Dividend stocks can be the foundation of a great retirement portfolio. Not only do the payments put money in your pocket, which can help hedge against any dips in the stock market, but they're also usually a sign of a financially sound company. Dividends also give investors a painless opportunity to reinvest in a stock, thus compounding gains over time.
However, not all income stocks live up to their full potential. Using the payout ratio -- i.e., the percentage of profits a company returns to its shareholders as dividends -- we can get a good bead on whether a company has room to increase its dividend. Ideally, we like to see healthy payout ratios between 50% and 75%. Here are three income stocks with payout ratios currently below 50% that could potentially double their dividends.
As the saying goes, dividend investors could find themselves "in good hands" with Allstate (NYSE:ALL), if they're willing to give the property liability and life insurance products provider a closer look.
Like most insurers, the biggest factor working against Allstate is persistently low lending rates spurred by the Federal Reserve's desire to reinvigorate U.S. economic growth. Low lending rates are great for the consumer, but Allstate and other insurers often lug around pooled premium money worth tens of billions of dollars that's being invested in high-quality, interest-bearing bonds, which, at the moment, are yielding very nominal returns.
However, this crutch could also be an intriguing reason to buy into the Allstate story. Presumably, lending rates are going to rise and return to a "normal" level, which is probably around the 2% mark that the Fed has been targeting in the intermediate term. This would mean over the coming years we could see 100 to 150 basis points in interest-rate expansion, and thus a big jump in net investment income for Allstate. Allstate had $57.3 billion in fixed-income securities as of the end of the first quarter, and even a minor bump in interest rates could mean a big boost in profits.
Catastrophe losses are also a perfect reason to consider buying into Allstate. Catastrophes are an inevitable part of being an insurer, and because acts of God and weather patterns are relatively unpredictable, insurers will, from time to time, deal with losses. In Q1, Allstate reported $827 million in property-liability catastrophe losses, which removed 10.7 percentage points in margin from this segment. Some see catastrophes as terrible news and sell off a stock because of it. But, catastrophes can be quite the opposite for insurers, as it gives full justification for across-the-board premium price increases to rebuild their premium float. It's this pricing power, and the necessity of buying insurance for your home and automobile, that makes the insurance industry so profitable as a whole.
Currently paying out $1.32 annually (2% yield), but pegged by Wall Street to bring in over $6 in EPS by 2017, a doubling in Allstate's dividend seems quite possible in the coming five-to-10 years.
Next, I'd suggest turning your attention to the technology sector and taking a peek at Avnet (NYSE:AVT), a global distributor of electronic components, IT solutions, and services.
Right off the bat you can probably guess what Avnet shareholders' biggest concern is; and if you said slowing growth in the traditional enterprise PC market, then you can pat yourself on the back. Legacy PC products continue to find themselves under pricing pressure as data shifts more and more into the cloud. This has been a bit of a problem for Avnet's Technology Solutions segment, which provides motherboards, DRAM module technologies, hard drives, and microprocessors to general-purpose computer and system manufacturers.
Now for the good news: Avnet is also moving beyond its legacy enterprise PC business and pushing into the cloud. The rise of data centers and the cloud will still mean plenty of demand for storage and processing solutions. Even though we've seen weaker spending in storage and servers from enterprise customers of late, I don't believe this is a trend that'll continue for too much longer.
Furthermore, Avnet reported in its fiscal third quarter that its All Flash Array storage business grew 40% year-over-year, and sales of its converged infrastructure offerings jumped 20%. With investments in next-generation technologies taking shape, and Avnet also aligning itself to be a supply chain player for the Internet of Things and embedded technologies, this company still has plenty of levers it can pull beyond just cost-cutting (which it's doing as well).
With Avnet's legacy enterprise PC solutions business revenue shrinking, but still generating healthy cash flow, it would make sense for Avnet to consider rewarding long-term investors with a beefier dividend payout. Currently paying out $0.68 annually (1.7% yield), but on track for $4.42 in EPS in fiscal 2017, Avnet appears to be a strong candidate to dramatically boost its payout.
Finally, income seekers looking for a buy-and-hold type investment would be wise to dig into Raytheon (NYSE:RTN), which provides everything from integrated defense solutions and missile systems to cybersecurity protection.
There are a number of factors that allow Raytheon to stand out from its other large industrial peers. For starters, Raytheon has a very clean balance sheet relative to many of its competitors. Raytheon is currently carrying $5.3 billion in debt on its balance sheet and about $2.6 billion in cash, with a total debt-to-equity of about 50%. That's low enough to give Raytheon the flexibility to make acquisitions – which it recently did by closing its purchase of cybersecurity firm Websense for $1.9 billion – while also allowing it ample cash flow to reinvest in new product growth. Comparatively, Lockheed Martin and Northrup Grumman have debt-to-equity ratios of 481% and 114%, respectively, which could inhibit their business model flexibility, or ability to make acquisitions.
Raytheon also isn't solely reliant on the U.S. Department of Defense, even though it is one of the company's customers. Doing business in some 80 countries allows Raytheon to take advantage of the growing demand for missile defense systems and cybersecurity beyond just the confines of the United States. A quick look at the company's backlog as of Q1, $34.8 billion, a nearly $2.3 billion in increase over the prior-year quarter, demonstrates the importance of this geographic customer diversity.
Raytheon's current yield of 2.3% is also pretty decent since most capital goods companies pay out a yield that's below the average yield of the S&P 500 (mostly because of high capital reinvestment costs). However, it's my belief that Raytheon's annual payout of $2.93 per share could double within the next decade given that Wall Street expects it to earn in excess of $10 in EPS by fiscal 2019. Assuming it wisely manages its costs and debt, Raytheon could make for a solid income investment.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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