Investors typically don't think of internet stocks as dividend payers. That is typically reserved for slower-growth industries such as consumer staples or utilities. Now may be the time to switch up this mindset as more and more technology companies start returning capital to shareholders in the form of dividends, including Alphabet (GOOG 0.87%) (GOOGL 0.75%).
The owner of Google Search and other internet properties has started to pay a small dividend to shareholders, which currently yields 0.47%. While small, the cash generating machine has a ton of room to grow its dividend per share in the years to come as it takes advantage of the age of artificial intelligence (AI).
At a stock price of around $170, Alphabet is the best dividend growth stock you can buy for your portfolio right now. Here's why.
Already winning in AI
Investors fear Alphabet will lose its dominant position in Google Search because of upstart AI tools, but this has not happened yet. In fact, you could argue that AI is actually helping Alphabet's business. Google Search keeps growing revenue at a double-digit rate -- 12.5% year-over-year growth last quarter -- with a lot of new revenue coming from its AI features.
More importantly, the AI sector is supercharging the Google Cloud business. Revenue at Alphabet's cloud computing division is growing 30% year over year and hit $12 billion last quarter. The division is now highly profitable, posting over $2 billion in operating income last quarter. As more and more companies load up to spend on AI, Google Cloud's revenue should keep growing.
All these segments growing at a double-digit rate will lead to more operating income growth at Alphabet. Operating income hit a record of $112 billion in 2024. On average, these earnings will get converted to free cash flow that will help fuel an increasing dividend payout. That is how you connect the potential in AI to Alphabet's potential as a dividend growth stock.
NASDAQ: GOOG
Key Data Points
The dividend growth formula
Right now, Alphabet pays a quarterly dividend of $0.20 per share. It implemented this dividend less than a year ago. At current prices, this is a dividend yield of less than 0.5%, which doesn't look highly attractive for income-focused investors.
However, over the next 10 years there is room for Alphabet to significantly grow its dividend. The company keeps growing earnings, which will increase its dividend payout capacity. On top of earnings growth, management consistently repurchases stock to bring total shares outstanding down. Shares outstanding have fallen by 11% in the last five years, which makes it easier for the company to grow its dividend-per-share payout for the simple reason that there are fewer shares outstanding with dividend obligations to pay.
Today, Alphabet's free cash flow per share is $5.70. This number might be temporarily compressed because of the huge capital investments Alphabet is making in cloud computing and AI infrastructure. However, over the long term I expect this figure to rise. Today, Alphabet's annualized dividend per share is $0.80, or only 14% of its free cash flow per share. This gives the company a long runway to grow this dividend by five- or even ten-fold over the next decade. As long as free cash flow per share keeps growing, of course.
GOOG Dividend Yield data by YCharts
Why Alphabet is a smart dividend growth stock to buy now
The key to Alphabet's dividend growth will be earnings growth. Without earnings you have no way to sustainably grow a dividend. But why should you have confidence in Alphabet's durable earnings growth?
It comes down to diversified revenue streams and competitive advantages. Alphabet earns money in a lot of ways, including Google Search, YouTube, and Google Cloud. If one of these segments struggles, it doesn't mean the entire business will fall apart. Alphabet also has a lot of competitive advantages, or competitive moats, which is what legendary investor Warren Buffett cares the most about when making an investment.
The YouTube business has a network effect, meaning that the more people join and post videos the more valuable the service gets for everyone else. Google Search has a distribution advantage by being the default choice in the Google Chrome browser and other free services in the Google ecosystem. Google Cloud will see economies of scale as it gets larger and larger, making only other scaled players the true competitors in this space.
I believe Alphabet will see steady earnings growth for years to come. This will help fuel the company's dividend payouts and help it turn into one of the great dividend growth stocks of the next few decades. Now is the time for dividend investors to hop on the Alphabet train as it is just getting started on its dividend journey.
