It might be worth buying a stock with a relatively low dividend yield today with the expectation that you'll get a much higher yield on your original investment in five or 10 years. In the meantime, good dividend growth stocks have the potential to produce market-beating returns. Dividend growers and initiators produced an average annual return of 10.24% over the past 50 years, according to data from Ned Davis Research and Hartford Funds. Non-dividend payers, on the other hand, produced a negative return in the same period.
These three dividend growth stocks all have the potential to produce market-beating returns with consistent dividend increases for years to come.
1. Starbucks
Starbucks (SBUX 0.47%) is the king of coffee. Its brand is synonymous with "coffee shop," and it has over 38,000 locations around the world. Even so, it sees room to keep expanding, growing to 41,000 locations next year and 55,000 by the end of the decade.
Despite adding thousands of stores every year, it's managing to grow comparable sales and exercise operating leverage. Comparable sales increased 8% in 2023, and management expects another 5% to 7% in same-store sales in 2024. That strong comp growth combined with increased prices and improved operational efficiency led to a 2-percentage-point expansion in operating margin last year.
Management sees room for strong continued bottom-line improvement relative to revenue, with earnings per share (EPS) growing 15% to 20% next year and long-term expectations for 15% annual growth. That will support its growing dividend, which it just raised 7.5% to $0.57 per quarter. With the bottom line improving quickly, there should be a lot more room for continued dividend increases as management aims for a 50% payout ratio.
The stock currently trades for 24.7x the midpoint of management's fiscal 2024 earnings guidance. That's in line with many other large restaurant stocks, but it's well below the company's historic price-to-earnings multiple. That makes it a great stock to buy for dividend growth investors.
2. CVS Health
CVS Health (CVS -0.22%) is a one-stop shop for healthcare: a retail pharmacy, a pharmacy benefits manager, and an insurance provider.
This year it added two health services to the fold with the acquisitions of Signify Health and Oak Street Health. Those acquisitions cost a pretty penny -- $8 billion for Signify, $10.6 billion for Oak Street -- and investors might think CVS overspent. CVS Health will acquire Oak Street Health's outstanding shares for $39 per share using existing financing capacity, maintaining its current credit ratings.
Indeed, the share price has fallen 24% year to date. But it's not just acquisitions that are to blame.
Like other health insurance companies, CVS has seen an increase in utilization, meaning it's had to pay out more benefits from delayed medical procedures. That's weighed on earnings, and management's revised its full-year guidance downward with every quarterly report this year.
But management is optimistic for the long term. It sees the addition of its newest acquisitions as a driving force behind accelerating its earnings-per-share growth back into double-digit territory. That'll be helped by its continued share buybacks, which complement its dividend nicely.
The stock currently pays a dividend yielding about 3.4%. But the payment has grown 10% per year since management resumed dividend increases last year. As earnings growth returns to a similar pace, that payout increase seems sustainable.
Shares currently trade at just 7.9x free cash flow, well below its historical average and less than its peers. So, now appears to be a great time to buy up shares of the stock.
3. T-Mobile
T-Mobile US (TMUS -0.06%) has gone from the scrappy underdog to a leader in wireless over the last decade. After completing the integration of Sprint's network and customers with its own, it's quickly become a massive free-cash-flow generator, and it just started paying a dividend this quarter.
The wireless service provider generated $4 billion in free cash flow in the third quarter, up 94% year over year. Management expects to continue improving its free-cash-flow generation, targeting $16 billion to $18 billion next year and more than $18 billion in 2025 and beyond. That'll put its free cash flow on par with its high-dividend-paying competitors in the not-too-distant future.
In the meantime, management is more focused on using its capital to buy back shares. It has $17.5 billion earmarked for capital returns through the end of next year, with about $13.75 billion of that dedicated to repurchases. That's a sign management believes the stock is still undervalued at today's price. It also gives the company room to remain flexible and take opportunities to buy new assets or companies if they arise.
Importantly, the low payout ratio means there's a lot of room to increase the dividend going forward. While the stock yields just 1.8% today, management plans to increase the dividend 10% per year for the foreseeable future.
With shares trading at 12.6x its outlook for 2023 free cash flow, the stock is certainly more expensive than other telecom giants. But with the strong free cash flow growth and the promise of consistent dividend increases, it's worth the price for dividend growth investors.
