Income mutual funds focused on dividend growth can be good sources of ideas about what’s hot and what’s not in the dividend growth-focused investing of the professionally managed money. Dividend growth investing has been especially appealing for income investors in the low-yield environment, in addition to this particular market-beating strategy. This has been the case because dividend yields complemented with dividend growth rates often well exceed the rate of inflation, providing for meaningful real income returns. In contrast,fixed-income securities such as government bonds have recently been offering paltry yields that made dividend growth stocks more appealing.
Below is a closer look at five stocks that professional mutual funds’ portfolio managers were adding to their portfolios in recent months. All these stocks yield more than 2% and are selected for review due to their dividend growth potential.
Whirlpool
Whirlpool Corporation (NYSE:WHR), world’s largest appliance seller, is in for a bright future, particularly as household incomes in emerging markets grow with rebounding economies. Analysts peg its long-term EPS CAGR at a superb 28.1% for the next five years, which should allow for robust dividend growth, given the company’s low payout ratio of 26% of the current-year EPS estimate. While the stock’s yield is relatively low at 2%, the ample room for dividend growth makes it appealing for dividend growth investors. What’s more, the stock is trading at only 11.4x forward earnings, providing for an exceptional value.
For obvious reasons, global demand for Whirlpool Corporation (NYSE:WHR)’s products has been lackluster in recent years, but the outlook has improved along with the rebound in the U.S. housing market and pent-up replacement demand, which is expected to play out over the medium-term period. The company’s strength is its broad geographic exposure and strong brands, as it markets products in nearly every country and has six brands valued at more than $1 billion. Whirlpool Corporation (NYSE:WHR) boasts a large opportunity in terms of market penetration in emerging markets, especially in India, China, and Latin America, where the company has average penetration of less than 10%, about 20%, and less than 40%, respectively.
The company has been producing solid operating profits, propped up by an improving operating margin due to fixed-cost cutting, improving productivity, and product innovation. Product price and mix have also helped boost financial performance. The trend is likely to continue, as the company aims at expanding its operating margin through cost cuts and sales improvements to 8% by 2014 (from the first-quarter’s 6%), extending into the future the streak of five consecutive quarters of year-over-year improvements in operating margins. These trends will support strong underlying cash flow generation in 2013 and beyond, providing sufficient room for robust dividend growth.
Norfolk Southern
Norfolk Southern Corp. (NYSE:NSC) is one of the ultimate dividend growers. This rail transportation company makes the ranks of the very few dividend stocks that have achieved average dividend growth of more than 10% for at least 10 consecutive years. In fact, Norfolk Southern Corp. (NYSE:NSC) has raised its dividend at a 21% CAGR over the past decade and it boasts 11 consecutive years of dividend growth. The company’s strong operational performance has enabled such dividend growth. Notwithstanding the deep coal traffic slump in recent years, Norfolk Southern Corp. (NYSE:NSC) was able to achieve its best ever operational performance in the past two years, with record revenues, operating income, net income, and EPS in 2011, followed by the second-best year on record in 2012.
The outlook continues to be dreary for coal shipments, due to the coal’s weak position amidststrong competition from cheaper natural gas, higher stockpiles, and weaker export markets, mainly in Europe and Asia. However, Norfolk Southern Corp. (NYSE:NSC)’s growth is supported by stronger intermodal and merchandize rail traffic. Intermodal traffic is receiving a boost from continued opportunities for highway conversion and growth with international shipping companies. To support growth in this segment, Norfolk Southern Corp. (NYSE:NSC) is launching new intermodal traffic terminals and service lines. On the other hand, the housing market strength, auto industry growth, and oil output expansion and transportation are buoying the rail merchandize segment. These positive trends should continue, as the robust population growth will support doubling of freight traffic by 2050.
Aside from the economically driven fundamentals, the company is also realizing cost efficiencies that are supporting its bottom line. Its indicators of crew starts, re-crews, train and engine service overtimes, and carloads/units per locomotive, have all been increasing at a solid clip.Moreover, Norfolk Southern Corp. (NYSE:NSC)’s bottom line is buttressed by respectable share buyback activity, including the last authorization back in August 2012, for 50 million shares through the end of 2017. The stock is yielding 2.6% and has a payout ratio of only 36% of the current-year EPS estimate. Analysts’ consensus EPS estimates for both 2013 and 2014 have been going up over the past three months.
Walgreen
Walgreen Company (NYSE:WAG), the largest U.S. drugstore chain, boasts a track record of 37 consecutive years of dividend increases. The streak is expected to continue into the future, given this company’s low payout ratio of 34% of the current-year EPS estimate and projected EPS growth of 13.5% annually for the next five years. Walgreen Company (NYSE:WAG) is presently yielding 2.2%.
Last year, the company’soperational performance was battered by a standoff with Express Scripts Holding Company (NASDAQ:ESRX), which resulted in client loss that hurt sales. Resolution of this stalemate has started to result in improved sales trends, even thought competitors still retain the majority of Walgreen Company (NYSE:WAG)’s customers gained during the Express Script standoff. The trend, however, is encouraging, and the current momentum looks poised to extend into the coming period. Walgreen Company (NYSE:WAG)’ sales in the fiscal third quarter, ending May 31, increased 3.3% year-over-year, with comparable store sales up 1.3% and prescriptions filled at comparable stores up 7% from the year earlier. Monthly sales indicate a rising momentum, as May sales rose 4.3% year-over-year, above the quarterly average, and total sales in comparable stores increased 2.8%. Prescriptions filled at comparable stores were up 7.1%, and would have been even higher without the adverse impact of the calendar shifts.
The company has embarked on new initiatives that are likely to boost its financial performance. Walgreen Company (NYSE:WAG)’s earlier-announced 10-year supply partnership with AmerisourceBergen Corp. (NYSE:ABC) will be beneficial to both parties in terms of sales and earnings. Moreover, it gives Walgreen Company (NYSE:WAG) and Alliance Boots the right to purchase up to 7% of AmerisourceBergen Corp. (NYSE:ABC)’s stock in the open market, as well as warrants exercisable for 16% in the aggregate of AmerisourceBergen Corp. (NYSE:ABC)’s equity. In addition to this deal and Alliance Boots’ synergies, the company’s long-term prospects are supported by aging populations, accretion from the implementation of the healthcare reform, higher healthcare spending, greater penetration of generic drugs with higher margins, and emerging market expansion.
Ford
Ford Motor Company (NYSE:F), the second biggest U.S. automaker by market share, is also one of the recent dividend growth picks of income mutual funds. The company has seen a major sales turnaround in the United States, where, last month, it posted its best May new-vehicle sales tally in years. In fact, Ford Motor Company (NYSE:F)’s14% gain in U.S. vehicle sales in May made for the best May since 2006. The F-series pickup trucks posted a 31% increase over the past year. The robust U.S. demand is supported by the U.S. energy boom and recovering construction markets, including the housing market’s expansion. The trends are also positive because of a pent-up replacement demand, as the age of the U.S. passenger fleet hovers aroundrecord-high levels.
Interestingly, demand for Ford Motor Company (NYSE:F)’s hybrid models is particularly robust this year—theautomaker has sold more hybrid vehicles this year than it has in any full year, breaking the full-year record set in 2010.These positive sales dynamics are helping Ford Motor Company (NYSE:F) increase its U.S. market share and are prompting productionincreases. As a result, last quarter, the company posted its 15th consecutive quarter of profitability.
However, the environment remains challenging in many markets outside the United States. In Europe, the company is enduring losses, but the outlook is improving, with expectations the company’s European operations will break-even within two years. In the Asia-Pacific-Africa region, Ford Motor Company (NYSE:F) will break-even this year, reflecting strong growth in volume, market share, and revenue. The rebound in global economies, and especially the rising middle class in emerging markets, bode well for the automaker’s growth potential in the long run. This is reflected in the company’s China growth, where May sales rose 45% from the year-ago levels, breaking records in passenger vehicle sales.
There are also several additional positives about Ford Motor Company (NYSE:F). Ford’s competitive edge over competitors rests with its short product cycle and the capacity to introduce new models faster than competitors.The company has achieved 12 consecutive quarters of positive cash flow. It boasts a solid balance sheet, with17.8% of its assets in cash and short-term investments and net receivables that cover almost 80% of the company’s long-term debt. Ford Motor Company (NYSE:F)’s stock is cheap at 9.2x forward earnings, especially given its 2.6% dividend yield (with a low payout ratio of 28% of the current-year EPS estimate) and the forecast long-term EPS CAGR of 11.9%.
Ace
ACE Limited (NYSE:ACE), one of the world’s largest multiline insurance providers, boasts dividend growth potential, following an increase in the company’s dividend by 4.1% in May. As a result, the current yield stands at 2.3%, while its payout ratio is low at 25% of the current-year EPS estimate. However, it should still be considered that the company’s strategy to grow through acquisitions could claim a notable portion of available cash flow to fund expansion. The long-term profitability outlook for the company is positive, as analysts see its long-term EPS CAGR at 8.1%. For the reference, the company’s net written premiums grew 5% last year, while adjusted diluted EPS was up 12%.
This insurer has a strong competitive position in its industry, characterized by operating outperformance relative to its peers and a focus on underwriting discipline. Its operating ROE has been consistently higher than the comparable metric for its peers on average. (The company targets a long-term ROE of 15%, which it is expected to reach within 2 years.) On the other hand, its P&C combined ratio has been consistently lower than that of its peers on average.
Operating in 53 countries, Acehas a broad geographical reach and offers a diversified portfolio of products, which adds to its strength. While low interest rates and rising operating expenses have weighed on the insurer’s financial performance in recent years, the prospect of rising interest rates provides some support to improved investment income outlook for the upcoming period. It also lends support to expectations of a higher ROE. In fact, every 100 basis points move in its portfolio book yield is worth almost 2 points of ROE.
The company’s strategy has been to channel excess cash into reinvestments, including acquisitions, instead of share buybacks. Therefore, the company has grown in scale and scope, with very accretive acquisitions that have been supporting ROE expansion. Still, as of the end of the first quarter, the company had some $307 million in share buyback authorizations. Moreover, the company has been building shareholder wealth through growth in book value, which increased by nearly 360% over the past decade. ACE Limited (NYSE:ACE)’s focus on growth, including both organic and acquisitive growth, with robust ROE targets, points at potential for continued future outperformance.
Final thoughts
Yields on Treasuries have now started to rise, increasing the appeal of these low-risk fixed-income investments. However, the prospect of moderately rising inflation still makes the case for dividend growth investing. The aforementioned companies—Ford Motor Company (NYSE:F), ACE Limited (NYSE:ACE), Walgreen Company (NYSE:WAG), Norfolk Southern Corp. (NYSE:NSC) and Whirlpool Corporation (NYSE:WHR)—each represent intriguing situations worth watching, and their support from mutual funds warrants closer inspection. Discover the secrets of another “smart money” strategy here.
Disclosure: none
