Veteran investors know that the best dividend stocks aren't those with a high yield, but rather are quality businesses that can grow over time and pass along profits to shareholders through the dividend, by repurchasing shares and reinvesting in the business.
United Parcel Service (UPS 0.02%) followed a record 2020 with a record 2021 performance. It also just raised its dividend by 49% -- its largest increase in company history. Here's why UPS is my top dividend stock to buy in February and why you might want to consider it yourself.
A thriving business
UPS' "better, not bigger" framework has centered around growing the quality of its revenue through higher-margin outlets like small and medium-sized businesses. UPS has also expanded routes and improved its flexibility, which has helped it navigate supply chain challenges. As a result, UPS' earnings and free cash flow (FCF) growth has accelerated at a faster growth rate than revenue -- which indicates that UPS is converting more sales into profit.
Additionally, UPS stands out for having a high operating margin. Operating margin is simply operating income divided by sales. It shows how much money a business is making before paying interest and taxes.
UPS finished 2021 with a 13.2% operating margin, which was its highest in 15 years. This means that for every dollar UPS earned in sales, it pocketed roughly 13 cents before interest and taxes -- which is excellent given UPS generated $97.3 billion in 2021 sales.
UPS is a large and bulky company with over 530,000 employees. One would think that its profitability would come under pressure as it expands its international footprint, when in fact the opposite has been true. Not only is UPS performing at a high efficiency relative to its past results, it's also a much more efficient business than its closest competitor, FedEx (FDX 1.37%).
UPS Operating Margin (TTM) data by YCharts
Over the last six years, UPS has separated itself from FedEx by maintaining a higher operating margin. It also continues to perform better during tough times, as FedEx was much more challenged during the U.S.-China trade war of 2018 and faced greater supply chain disruptions and labor challenges in 2021.
A stable and growing dividend
A high operating margin sets the tone for a strong business that converts sales into profits. In June, UPS set the goal of passing along 50% of its adjusted earnings per share (EPS) to its shareholders through its dividend. Given that it earned $12.13 in 2021 adjusted EPS, it made good on its promise by raising its quarterly dividend to $1.52 per share, or $6.08 per share per year.
UPS' 50% payout ratio gives it plenty of dry powder to reinvest in its business. And that's exactly what it plans to do. 2022 capital expenditures are expected to be $5.5 billion, a 31% increase compared to 2021. On its Q4 2021 conference call, UPS noted that 60% of total 2022 capital spending will go toward growth projects and 40% will go toward maintenance. Growth projects include building more delivery centers, automating certain functions, and investing $1 billion in carbon-neutral initiatives.
The beauty of UPS is that it can grow its business, pay a dividend, and buy back stock. This gives UPS a big advantage in that it can invest in ventures that may take years to pay off, such as automation. "We just started the first phase of what we're calling smart package, smart facility, which, over time, will put [Radio Frequency Identification] RFID tags on all of our packages. This initiative will enhance customer experience while improving UPS productivity by eliminating millions of manual scans every day," said UPS CEO Carol Tomé during the company's Q4 2021 conference call.
RFID tags will help UPS improve its tracking services and customer experience. It's one of several measures the company is implementing to drive efficiency and increase its operating margin.
UPS is built to last
UPS' dividend increase gives its stock a dividend yield of 2.7%. But unlike other dividend stocks, UPS' investment thesis isn't solely based on generating income from its dividend. UPS is the undisputed industry leader in the package delivery industry. Its strong momentum heading into 2022, paired with a healthy balance sheet and a business that can perform well during times of inflation, lay the groundwork for another strong year.
UPS may not be the most exciting business, but it makes up for that lack of flair with dependability. If the market sell-off persists, investors can be confident in the long-term strength of UPS' business. The same can't be said for companies with lofty valuations or those that lack the track record of outlasting past economic downturns.
