2 Dividend Growth Stocks of the Future

There are few investments hotter than dividend growth stocks. Following the 2008 financial crisis, many investors saw the risks inherent in stocks built solely for capital appreciation. Why not look for capital appreciation and cash dividends at the same time?

The logic follows that a portfolio that spins off cash dividends can provide current income, regardless of where stock prices go. And thanks to dividends, investors won't have to sell shares at less-than-opportune times (say, 2009) to raise cash for immediate needs.

The dividend growth stocks of the future
A list of dividend aristocrats (dividend stocks that have increased dividends for 25 years or more) gives you a look at history's best dividend stocks. You'll find conventional widow-and-orphan stocks in this list -- Coca-Cola, Procter & Gamble, and Johnson & Johnson.

What about the dividend stocks of the future? If I had to make a wager, I'd place my bet on Visa (NYSE: V  ) and MasterCard (NYSE: MA  ) becoming full-blown dividend growth names in the decades to follow.

Here are three reasons.

1. They're cash cows
Payment processing is a truly remarkable business. It's effectively a duopoly market, with Visa and MasterCard playing part in nearly 90% of all transactions. Discover and American Express merely pick up the scraps. Thus, Visa and MasterCard have ample pricing power, which can be found in their impressive margins.

Net margins at Visa have hovered around 40%; MasterCard's have been in the mid to high 30% range. In both cases, free cash flow has closely mirrored net income over time, so this isn't a case of earnings on accrual. Instead, Visa and MasterCard's earnings are coming in the form of cash -- cash that can be paid out as a dividend.

2. Valuation
Neither Visa nor MasterCard are cheap, trading at more than 20 times 2015 earnings estimates, and nearly 30 times earnings in 2013. Both, however, are consistently repurchasing shares. Visa is the most aggressive buyer of its own stock, spending some $5.3 billion on share repurchases in its 2013 fiscal year. MasterCard's repurchases are much smaller, coming in at $2.3 billion in the last 12 months.

Since a majority of Visa and MasterCard shares are held by institutional investors -- many of which are buy-and-hold investors -- their ability to repurchase shares may be limited in the future. With much of the float controlled by institutional investors, and both being fairly valued, a dividend may make more sense than growing, ongoing repurchases.

3. Future growth
There are only two limits to a growing dividend: the payout ratio (percentage of income paid out as a dividend) and growth in net income. Future growth is much more important given their low payout ratios and growth-stock valuations.

Of course, it is growth that makes the payment processors attractive. MasterCard suspects that 85% of global payment volume is done in cash. Over time, the mix should shift to digital forms of payment, preferably cards with a Visa or MasterCard label. This will only fuel growth as more and more transactions are done over payment networks, with the payment processors collecting fees on every swipe.

In the last five years, Visa has averaged annual revenue growth of roughly 13.5%, compared to 12.7% growth for MasterCard. During this same period, global economic growth topped at 5.3% in 2010, and bottomed at -0.5% in 2009. Clearly, Visa and MasterCard are very capable of growing faster than the global economy thanks to a shift from cash to card.

The Foolish bottom line
We're in the first innings of the payment processing boom, and Visa and MasterCard are natural beneficiaries. Luckily for investors, Visa nor MasterCard require significant new investments to grow, generate billions in annual cash, and pay out only a fraction of their income as a dividend.

MasterCard's recent announcement of a bigger dividend marks three years of consistent dividend increases. Visa is now on track for six straight years of dividend increases. This is behavior consistent with companies wanting the coveted dividend growth stock crown, and the reason I believe Visa and MasterCard should be on any dividend stock investor's radar.

Nine dividend stocks to buy and hold forever
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend-paying brethren. The reasons for this are too numerous to list here, but you can rest assured it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

Read/Post Comments (6) | Recommend This Article (14)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 30, 2014, at 7:46 PM, IdaAg wrote:

    I thought I'd just seen many advertisements from Motley Fool trying to get me to buy into the next huge growth stock that would eliminate credit cards. Now, this author is saying Visa and Mastercard are great investments. Which way is it? It certainly isn't both for the long term.

  • Report this Comment On January 30, 2014, at 7:56 PM, hanover67 wrote:

    Company's repurchase activities are usually expressed in dollars, but what percentage of the outstanding shares do these amounts represent, and what is the actual or potential impact on earnings per share? If a company's market value is $100 Billion and they repurchase $2.3 Billion, big deal. And, they usually buy stock back at the high end of the market price.

  • Report this Comment On January 30, 2014, at 8:23 PM, agrigold wrote:

    The two comments have valid points. What are the answers

  • Report this Comment On January 31, 2014, at 3:16 AM, hotpepperaddict wrote:

    what about bit coin?

  • Report this Comment On January 31, 2014, at 9:07 AM, grandpa1 wrote:

    V & MA pay approx .7 and .6 percent, per Yahoo (and in the case of V with a very high dollar investment). If they each double over the next 5 years, they still pay less than 1.5%.

    I think my dollars should be in DUK or GE or other solid payer already paying double double either V or MA (and I can spread the same $ around to 2, 3 or 4 stocks)

    Sorry, but I want the income now. How long would I need to live/wait with V/MA for them to catch up in percent and then make up the difference in lost income from the early years.

    They might look good in the long run but in the long run we are all dead.

  • Report this Comment On January 31, 2014, at 3:34 PM, TMFValueMagnet wrote:

    Hanover67, Visa repurchased about 4.4% of its diluted share count. MasterCard repurchased about 3.2%. This was in the last 12 months prior to earnings this week (to keep consistent with numbers in the article.)

    Grandpa1, MasterCard increased its dividend 89% when it upped it to $0.11 per share in December. Visa increased its dividend 21% to $0.40 quarterly in October 2013. Sure, the current yield is low, but the growth rate is phenomenal.

    Consider this: MasterCard's split-adjusted quarterly dividend was $0.015 in 2008; Visa's was $0.105. Considering their earnings quality, and low payout ratio, there's plenty of room for growth. I do understand why someone seeking current income wouldn't be interested, however.

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