Right now, inflation is at a multi-decade high, the US economy is experiencing a downturn, and there are several additional macro troubles brewing, including the war in Ukraine.
This has led to volatile equity markets. But with inflation running at a high-single-digit rate, 3%-yielding treasuries don’t seem attractive, either.
Investors that want a combination of inflation protection, income, and resilience versus recessions may be interested in the Dividend Aristocrats, a group of S&P 500 stocks with 25+ consecutive years of dividend growth.
Quality dividend growth stocks such as the Dividend Aristocrats combine income generation potential and regular dividend increases, which helps combat inflation.
In this article, we’ll explore how investors can best decide what dividend growth stocks suit their needs and we’ll highlight a couple of attractive dividend growth choices as well.
Why Invest In Dividend Growth Stocks?
Many investors want to receive regular income from their stock holdings via the dividends they pay.
That’s especially important for retirees and other investors that live off their portfolio income, but even during the wealth-building phase dividends are important as they allow for reinvestment which boosts portfolio returns.
At the same time, when a stock pays a stagnant dividend, then inflation erodes investors’ buying power over time. Thus a combination of a considerable income yield with regular growth of said income is ideal — and that’s what dividend growth stocks have to offer.
Unlike fixed-income investments such as treasuries, investors are able to offset the negative impact of inflation on their income when they invest in equities that increase their dividends over time.
How To Invest In Dividend Growth Stocks
There are many equities that have increased their payouts over time, but not all of them are necessarily strong investments. There are several items investors should look at when researching potential dividend growth picks in order to make decisions that suit their needs.
The first item of importance is a stock’s dividend yield. When a company raises its dividend regularly, but the starting yield is too low, then that doesn’t really help when it comes to financing one’s retirement. Apple (AAPL) is an example of that — it has increased its dividend over time, but the yield is just 0.6%, which is too low for many investors.
Investors should also look at a stock’s past dividend growth performance. In general, a longer dividend growth streak is favorable versus a shorter dividend growth streak.
A company that has raised its dividend 50 years in a row has proven that it is able to maintain its dividend growth record through all kinds of macro crises, including the Great Recession, the dot.com bubble burst, and so on.
When that is the case, the company also has proven that it has put a lot of value on reliability when it comes to shareholder payouts. The chance that this company will continue to maintain its dividend growth track record is high, as no management team wants to get infamous for breaking a long dividend growth streak.
In a similar manner, the risk of a dividend cut also depends on several other factors. This includes the payout ratio: The portion of net profits that is paid out via dividends. A lower payout ratio means that the risk of a dividend cut is lower, as an earnings decline can be stomached more easily.
Likewise, a less cyclical or more resilient business model reduces the dividend cut risk as well. If a company is able to remain highly profitable during a recession, there is less risk of a dividend cut, relative to more cyclical industries such as basic materials, consumer discretionary, etc.
Last but not least, investors should also consider valuations before making investments. Even a quality company can trade at a too-high valuation, which will result in total return headwinds in the future. It’s better to opt for equities that trade closer to or even below fair value.
3 Quality Dividend Growth Stocks
There are many quality dividend growth stocks that may be suitable for investment. Here, we want to showcase three. All of them are Dividend Aristocrats, which means they have increased their dividends for at least 25 years in a row.
The first one is Lowe’s (LOW), one of the top two home improvement retailers in North America. The company has benefitted a lot from the strong housing market in the last couple of years and has seen its margins and profits expand. The dividend yield is at a solid level of 2.1% right now, following a recent dividend increase of 31%.
With a 58-year dividend growth streak and a 5-year dividend growth rate of 19%, Lowe’s is a dividend growth stock where the focus is on the “growth” part. Even though its yield is not ultra-high, we believe that Lowe’s could return 12%+ per year going forward thanks to its dividend, earnings growth, and multiple expansion potential.
3M (MMM) is a diversified industrial company that offers a very wide range of products in more than 100 countries around the world. This includes healthcare products, industrial products such as fasteners and adhesives, and so on. 3M has recently seen its shares decline, which has made its dividend yield rise to a compelling 5%.
With a 63-year dividend growth track record, 3M has proven ultra-reliable, although its dividend growth rate is much lower than that of Lowe’s, averaging 5% over the last five years. Still, between that and the current dividend yield, a 10% annual return seems quite possible. With some multiple expansion potential on top of that, returns could be even higher.
Walgreens Boots Alliance (WBA) is a pharmacy company that is active in North America and parts of Europe. It has managed to increase its dividend for 46 years in a row, which can be explained by its resilient business model. Demand for its pharmacy services is not too dependent on economic growth, after all. The company offers a dividend yield of 5.3% right now, which is quite attractive.
When we add the 5-year dividend growth rate of 4.6%, 10% annual returns seem pretty achievable. We believe that Walgreens trades below fair value today, which would allow for even higher returns going forward, thanks to the impact of (expected) multiple expansions going forward.
By Jonathan Weber for Sure Dividend