Finding a great dividend growth stock will pay off for years to come. Investors who bought MacDonalds (MCD) in 1990 would find their dividend paying well over 50% on their original investment every year since 2010. Also the company continues to raise it’s dividend so this return keeps growing regardless of what the stock price is doing. So how do we find companies who may have such stellar dividend growth for us for the next 20 years?
Investors can buy companies like MacDonalds if their stock price goes down and their yield goes up, but although they are likely to grow their dividend it is not likely to be as big of percentage as in their earlier years when the company had explosive growth.
There are things that need to be in place for a business to grow their dividends consistently. Here are six things I look for when buying to get dividend growth.
- Consistent earnings – GuruFocus gives ratings for predictability on earnings based on consistency over the past 10 years. Stocks with 2.5 stars up to 5 are pretty consistent in earnings and earnings growth.
- Revenue Growth – is key to safety and ability for a company to raise their dividends. I prefer revenue growth over earnings growth because earnings can be manipulated through expense cuts but a company can only cut expenses so much. If revenue is growing then the company should be able to grow their earnings and dividend. Also growing revenues mean strength in market share. The only way to grow them is to sell more product/service or increase prices which are signs of increasing market share.
- Payout Ratio – is how much of their earnings they have to give up for the dividend. If they pay a $1 a share dividend and they are earning $1 per share in income then all of their earnings are being used up for the dividend and if the earnings drop they will be paying from retained earnings or cutting their dividend. As a result I like the company to be paying a solid yield but a small percentage of their earnings so that combined with the revenue growth it will be easy for them to hike their dividend payments.
- Yield – while it is not a good idea to chase yield, as a value investor I am looking for under priced businesses. If a stock is selling at a discount then the yield will be higher than at fair value. Starting with a higher yield and having it grow helps one get to higher dividend returns earlier. When I do take a lower yield it is often for a higher revenue growth and lower payout situation which can provide very significant growth to grow the lower yield.
- Strong Balance Sheet – for a company to pay and grow dividends they must be also able to pay their debt. If they do not have a strong cash to debt and strong equity to debt ratio then earnings may be needed to service debt and that will stop the dividend growth.
- Management Commitment to raising dividends – Companies are not required to pay dividends and it is a decision. It is good to see or know that management is committed and motivated to pay shareholders. This can be from stating their intentions to the media, or a history of dividends and dividend increases.
Here are some companies I feel have solid dividends and have a good chance of raising their dividends (click to enlarge):
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