Dividend stocks come in all shapes and sizes, but sometimes it's the boring companies that surprise you. For example, you might expect a technology company like Apple to carry a fast-growing payout. But would you believe that a water-heater manufacturer and an air conditioning company are trouncing the iPhone maker on dividend growth? It's true, and those rising payouts are a really good reason to get to know A. O. Smith Corp. (AOS -1.48%) and Lenox International (LII 0.48%).
1. A new market will drive growth
If you live in a developed market, then there's nothing exciting about the water heaters that A. O. Smith makes. You're used to getting up and taking a warm shower without giving the infrastructure behind it much thought. However, that's not the case for people living in emerging markets, where hot water is an affordable luxury that people quickly add to their homes as they move up the socioeconomic ladder. To put some numbers on the trend, A. O. Smith projects its long-term sales growth will be in the low-to-mid single digit percentages annually in North America but is expecting mid-teens percentage growth rates in Asia.
In emerging markets like China, where sales grew at a 21% annualized pace over the past decade, its business is driven by the massive construction programs that support citizens moving from rural to urban areas. That and the sherr pleasure of using warm water instead of cold. China provides around a third of A. O. Smith's revenue, and its sales there have helped drive annualized earnings growth of 26% since 2010. That, in turn, has positioned the company to boost its dividend by an average of 17% a year over the past decade.
The most recent hike at A. O. Smith, meanwhile, was 22%. To put that in perspective, Apple's last hike was roughly 16%.
The future for A. O. Smith, meanwhile, is pretty compelling because it is working to capture a new Asian opportunity: India. Management believes its addressable market in the world's second-most-populous nation will more than double between 2020 and 2030. And it's still growing in China, where it's working to expand its reach into the water- and air-purifying markets.
Water heaters may be boring commodities, but if you are looking for dividend growth, A. O. Smith has proven it knows how to make boring look sexy for income investors.
2. Gaining share in the HVAC space
Lennox International makes heating and air conditioning equipment, which is another luxury most of us probably take for granted. But whenever you have to suffer without heat on a cold day, or air conditioning on a hot day, you suddenly realize just how important these products are to your life. Lennox's primary markets are North America (93% of sales) and Europe, so this stock isn't an emerging market story.
The driving force for Lennox's sales is the replacement of old units -- that makes up around 75% of the company's business, with a roughly 60/40 split between residential and industrial markets. The company's scale and reach are important -- it operates its own store network, while competitors generally use outside distributors. This gives Lennox more control over the customer relationship, helps it ensure its products are available where the demand is, and means it can be sure that installers are properly trained and supported. Although simple, these direct customer relationships are powerful drivers for repeat business. In fact, the company credits these distinctions for helping it to gain share in key end markets.
In addition, Lennox has been working to improve margins via cost-cutting efforts. It's been hugely successful on this front, improving its return on sales (the measure the company uses to track performance) from 7.6% in 2012 to 13.4% in 2017. It expects to hit 16.5% by 2020, so cost cutting will support the top and bottom lines for at least a few more years. This year and next, the company's results will be dragged somewhat due a natural disaster that struck one of its plants. However, that's unlikely to completely derail its long-term projections.
This is a company with an incredible dividend record: its annualized increase has been around 14% over the last 10 years, with roughly 20% increases over the trailing three- and five-year spans. The most recent bump was a whopping 25%! That almost makes Apple's recent 16% hike look like chump change.
Boring is beautiful
When you're looking for dividend growth stocks, it's easy to overlook companies with mundane product lines, and natural to assume they can't compete on growth with exciting names in headline-grabbing industries. But when you take a look at the numbers, boring companies like A. O. Smith and Lennox are providing dividend growth that puts some of the best-known tech companies to shame. Neither will knock your socks off on the yield front -- currently their yields are in the 1% to 2% range -- but if it's dividend growth you're after, they're hard to beat.