When you only invest in the highest-quality businesses, dividends can be a passive source of reliable and growing income that can help pay your bills in retirement. That's because the best dividend stocks raise their payout regularly and need minimal oversight on your part to make sure the investment thesis is holding up. But how can you identify these stocks?
One key trait of a best-of-breed dividend stock is the company's ownership of numerous brands that are consumed on a daily basis. Here's why I believe the confectioner Hershey (HSY -1.74%) fits this profile and what else makes it a wonderful dividend growth stock.
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1. It's a diversified collection of widely recognized brands
Hershey possesses a portfolio of over 90 leading brands that are sold in approximately 85 countries throughout the world. Hershey is best known for its sweet snacks. These snack brands include the eponymous Hershey's chocolate brand, the hard candy and gummy brand called Jolly Rancher, and the licorice brand named Twizzlers. Hershey is also striving to create and acquire healthier snacks.
Hershey has recently launched aspartame-free, zero-sugar Jolly Ranchers and York Peppermint Patties to capture the 70% of U.S. consumers who are concerned about the amount of sugar in their diet. The company also recently introduced organic Reese's Peanut Butter Cups and Hershey's chocolates at price points that are affordable to health-conscious consumers.
On the acquisition front, Hershey completed its acquisition of Dot's Pretzels earlier this month. With the $1.2 billion deal finalized, Hershey now owns the fastest-growing pretzel brand in the U.S. Dot's Pretzels contributed to 55% of U.S. pretzel category growth last year, which should be a prudent way for Hershey to branch out into salty snacks to meet the demands of consumers.
As a testament to Hershey's brand power, the company's existing brands prior to the acquisition of Dot's Pretzels delivered a 6.3% year-over-year increase in net sales to $2.36 billion in the third quarter. A year-over-year increase in adjusted net margin from 17.5% to 18.4% coupled with a slight decline in Hershey's outstanding share count led the company's non-GAAP (adjusted) diluted earnings per share (EPS) 12.9% higher to $2.10.
Due to its robust quarter and increased visibility with only one quarter remaining, Hershey raised its net sales guidance to 8.5% at the midpoint for this year. The company also raised its adjusted diluted EPS midpoint to $7.05 for this year, which would represent a 12% increase over last year.
Looking ahead, high-single-digit to low-double-digit annual earnings growth should persist. That's because analysts anticipate that Hershey's strategy of in-house innovations (i.e., zero-sugar and organic product launches) and add-on acquisitions will allow for 9% compound annual earnings growth over the next five years.
2. The payout ratio promotes a safe dividend
Hershey is a steady business with solid growth prospects for the foreseeable future. Another reason that income investors will love Hershey's stock is that its consecutive 12-year streak of dividend increases appears to be just the beginning of a much longer streak.
Here's what gives me confidence in the stock's market-beating 1.9% yield.
Hershey's dividend payout ratio will be 48.4% for this year based on the $3.41 in dividends per share that it has paid out. This low payout ratio builds in a buffer for Hershey to continue paying its dividend, even if profits temporarily decline. It also allows the company to retain the majority of its profits, so it can reinvest in the business to further grow profits in the future.
3. Hershey is a successful business at a sensible valuation
As a dividend growth stock, Hershey checks every box an income investor could possibly want. Brands consumed on a regular basis? Check. A business with consistently growing earnings? Check. A sustainable dividend payout ratio? Check. A market-beating dividend yield? Once again, check.
Let's conclude with a glance at Hershey's valuation relative to its industry to address whether the stock is a buy or if potential investors should wait for a pullback.
Hershey is trading at a forward P/E ratio of 25, which is a slight premium to the confectioner industry average of 22.2. Given Hershey's leading brands and the fact that its future annual earnings growth is projected to be slightly higher than its industry, this premium to its industry is arguably well-deserved. Therefore, I believe the stock is a buy for dividend growth investors at just 3% below its 52-week high.
