One time-tested way to improve your odds of outperforming the market is to focus on investing in high-quality businesses with long track records of dividend increases and sustainable payout ratios. A great place to start looking for companies that fit that description is among the Dividend Aristocrats -- companies in the S&P 500 that have increased their dividends for 25 consecutive years or more.
By narrowing your search to this group of stocks, you are essentially fishing in a stocked pond, as these battle-tested companies have already proven themselves consistently profitable and focused on shareholder returns. But one can find similarly strong choices among companies that don't quite qualify as Dividend Aristocrats yet. Kroger (KR +0.85%) and Nike (NKE 0.28%) are well on their way to achieving that lofty status, and their recent 10%-plus drops in share price offer an excellent opportunity for new investors to buy in.
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Kroger
Though some expected Kroger to be relegated to Amazon's (AMZN 0.87%) shadow following the e-commerce giant's acquisition of Whole Foods and its launch of Amazon Fresh, Kroger has not only survived but developed a thriving digital business of its own.
Kroger was already the second-largest grocery chain in the U.S., and it is rapidly building out its technological capabilities. Its digital sales have more than doubled since 2019, helping fuel two-year identical sales stack growth of 14% in the second quarter. (Many companies this year are offering growth numbers relative to their 2019 figures due to the unusual nature of 2020's business environment.)
Furthermore, Kroger's rewards program seems to be pairing nicely with its burgeoning digital business. Touching on this during the company's Q2 earnings call, CEO Rodney McMullen explained, "As an example, nearly 60% of all items in a digital basket were added through our personalization science, highlighting our ability to make meaningful suggestions that surprise and delight customers." Looking to build on these successful recommendations, the company expects to double its digital sales by 2023.
For the full year, management updated its guidance. It now expects around $3.30 in earnings per share and up to $2 billion in free cash flow. At its current market capitalization of about $30 billion, hitting those targets would have the company trading at just 15 times free cash flow and a price-to-earnings ratio of 12. That's relatively cheap compared to Amazon, which currently trades at over 100 times free cash flow and has a P/E ratio of 60.
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Nike
While it has a long history of success driven by its iconic brands, Nike is also in the midst of an operational transformation. It's looking to accelerate its direct-to-consumer business and connect with its customers personally while moving more of its sales online. As a result of these efforts, digital sales led Nike's growth story, up 25% for its fiscal 2022 first quarter, which ended Aug 31, compared to overall sales growth of 16%.
Nike's digital sales now provide 21% of its total revenue, a trend that is increasing its margins. Management's longer-term vision is to have digital sales from the Nike brand account for 40% of total sales by 2025.
Regarding Nike's efforts to deepen its customer relationships, CEO John Donahoe said, "Our membership strategy is working as we increasingly use data and analytics to personalize member product offering and experiences. And we're seeing this come to life as repeat buying members grew more than 70% in the quarter." All in all, Nike seems to be moving ahead quite nicely with its long-term transformation plans. As such, its recent share price drop -- which can be attributed to transient supply chain issues -- opens up a buying opportunity for investors.
Dividend Aristocrats in the making?
| Metric | Kroger | Nike |
|---|---|---|
| Dividend yield | 2.1% | 0.8% |
| Payout ratio | 48% | 29% |
| Dividend potential (yield/payout ratio) | 4.4% | 2.6% |
| Consecutive years of dividend increases | 15 | 19 |
Statistics from Yahoo! Finance
While Kroger and Nike each have a ways to go before they could earn the title of Dividend Aristocrat, they certainly seem like solid bets to make it, with reasonable payout ratios of 48% and 29%, respectively. Because they are paying out less than half of their income to shareholders, each company still has plenty of room to continue nudging its payouts upward regularly even as they retain cash that they can use to fuel new growth opportunities.
Overall, Kroger and Nike would make great additions to the portfolios of new investors or dividend growth investors.
