In an ongoing effort to tame inflation, Federal Reserve Chair Jerome Powell signaled that more interest rate hikes will be announced next year. This has financial markets again concerned about whether the Fed will be able to beat inflation without thrusting the economy into a recession. That is a big reason why the S&P 500 index nosedived 21% so far this year.
What is an investor to do in such uncertain times? The answer is the same as it always has been, which is to buy quality dividend growth stocks.
Shares of medical device maker Medtronic (MDT -1.12%) are down 28% year to date. But with 45 straight years of payout boosts to its name, the stock could be a buy for dividend growth investors seeking a stock to anchor their portfolio.
Navigating through headwinds
With a portfolio of medical devices designed to treat dozens of medical conditions and diseases, Medtronic reaches over 76 million patients each year. Thanks to its impressive product portfolio, the Ireland-based company is the largest pure-play medical devices business on the planet -- with a $104 billion market capitalization.
In late November, Medtronic shared its financial results for the fiscal second quarter that ended Oct. 28. The medtech company recorded $7.6 billion in revenue during the quarter. This was a 3.3% decline over the year-ago period.
At first blush, this dip in revenue seems to be discouraging. But there's a reasonable explanation for it: This is due to the fact that nearly half of Medtronic's revenue is derived in international markets. Factoring out the recent strength of the U.S. dollar against other currencies, the company's constant-currency revenue would have been $8 billion -- a 2.5% year-over-year rise.
Medtronic recorded $1.31 in currency-adjusted non-GAAP diluted earnings per share (EPS) in the second quarter. For context, this was a 0.8% decrease over the year-ago period. Slightly higher costs of products sold and lower selling, general, and administrative expense categories weren't enough to compensate for the lower revenue for the quarter. This is how the company's non-GAAP net margin fell 10 basis points year over year to 22.7% during the quarter. Medtronic's dip in revenue and profitability was partially offset by a 1.7% reduction in the diluted outstanding share count. That explains why the company's currency-adjusted diluted EPS growth rate eclipsed revenue growth in the quarter.
Medtronic spent $2.7 billion on research and development in its previous fiscal year. As the company builds on its record of clearing 200-plus regulatory approvals in the last 12 months and inflation cools off, profitability should rebound. This is why the average annual analyst-adjusted diluted EPS growth estimate of 2.9% for the next five years could prove conservative.
Image source: Getty Images.
A future Dividend King
Medtronic's 3.6% dividend yield is more than double the S&P 500 index's 1.7% yield. And if this superior starting income wasn't enough, Medtronic is on pace to become a Dividend King in 2027. A Dividend King is an S&P 500 stock that has raised its dividend annually for at least 50 consecutive years.
This ability to keep raising its dividend is because the company's dividend payout ratio is poised be around 52% in its current fiscal year. That's arguably a goldilocks payout ratio since it leaves enough capital for future growth opportunities and debt repayment while also rewarding shareholders with high beginning income. Given this optimal payout ratio, I believe that dividend growth will slightly exceed earnings growth over the medium term. If Medtronic can return to mid- to upper-single-digit earnings growth, the company should have no problem handing out high-single-digit-percentage dividend hikes to shareholders.
The stock is meaningfully discounted
Medtronic appears to be a no-brainer buy for income investors seeking value for their hard-earned money.
The company's trailing-12-month price-to-sales (P/S) ratio of 3.3 is materially below the 10-year median trailing-12-month P/S ratio of 3.9. Since Medtronic's growth prospects look to be about the same as over the last decade, this is arguably an attractive valuation to buy at for the long haul.
