Investing in great dividend stocks should be on every investor's radar for 2015. As a group, dividend stocks beat the market in good times and bad, but investors can do even better by choosing dividend stocks most likely to raise their dividend. McCormick (NYSE:MKC), Campbell Soup (NYSE:CPB), and Viacom (NASDAQ:VIAB) all share similar traits that could lead to higher dividends in 2015 and beyond. Here's why.
The most important thing
Why are future dividend increases so important? For one thing, the dividend yield gives investors a head start on a total return. A 3% yielding stock only needs to gain 5% to match the returns of an 8% non-dividend payer; if that 3% yielding stock doubles its dividend, the odds of a market-beating return go up.
Where your dividends are headed next is what matters, and a good way to gauge that is to look at the payout ratio, or the percentage of earnings paid out in dividends. Unless a company is remarkably non-capital intensive, payout ratios above 65% are risky. For maximum financial flexibility, seek out stocks with payouts below the market averages.
Businesses that keep their payout ratio below the S&P 500 average (about 50%) typically have money left to reinvest in their business -- and to increase their dividend. If that same stock with a below average payout uses that cash for dividends, and maintains a yield above the S&P average (1.9%), it will outperform the market on average. A study by Credit Suisse, tracking investment returns from 1990 to 2008, showed that stocks that met both criteria nearly doubled the returns of the S&P 500. There's not many dividend payers that meet the criteria of beating the S&P 500 average on dividend yield and payout ratio today, but the three stocks I've named all pass the test.
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Quality of a business
While a low payout ratio helps, it isn't the only indicator of future dividend increases. Ultimately, you must invest in a quality business that has the potential to raise cash flows, the driver of dividend payments, for years to come. One clue that can foreshadow robust cash flows is high returns on capital. Viacom, a stock with healthy returns on capital and cash flows, is a third dividend stock you should keep on your radar. As the chart below shows, Viacom has been growing in both areas in recent years as well.
Return on capital matters because it tells us how much money a business earns, versus the costs of starting and running the business. For every dollar you give Viacom to run its business, it's giving you (the investor) about $0.14 back. Campbell Soup and McCormick have healthy returns on capital as well: Campbell's ROC is over 15%, and McCormick is at 12.85%.
Valuation is relative
Of the three, Viacom (P/E of 12) and Campbell (P/E of 16) trade at a lower P/E multiple than McCormick's high P/E of 23. But we must remember that business performance is gauged in ways other than value and growth.
Take McCormick's dominant market share, for example. The spice maker is a whopping four times larger than its largest competitor. The company is more than just size, too. It projects annual growth at 3%-5% and faster in international markets, which currently make up about 40% of sales. If McCormick can simply maintain its market share and margins, then the dividend will be safe for years to come. While that isn't an easy feat for any company, this household name has a significant head start.
Campbell has the ill fate of being part of an "anti-trend." If you are bullish on organic food and healthy eating trends, then you naturally have to be pessimistic on Campbell. While I am optimistic about the fortunes of many natural food businesses, I feel this view of Campbell is seriously misguided. Not only is canned soup nowhere near the least healthy thing you can eat, but the company has promising healthy brands like Bolthouse Farms and Plum Organics that can capitalize on healthy eating trends. While the company has not experienced rapid growth recently, it is coming off of a quarter in which organic sales rose 5%, and EPS rose 9%, thanks in part to a strong performance by Bolthouse Farms.
Viacom, the cheapest name on the list by P/E, had a tough go in 2014, as full-year revenues were flat. However, it's coming off a strong quarter in which revenue grew 9%, and EPS jumped 10%. Earnings were still up for the year, and the company has a strong and diversified portfolio of media brands. This is the type of business that relies on multiple box office hits or popular new shows to grow sales, and it's size can work against it in this regard. But Viacom is profitable, it has terrific brands, and at 13 times earnings, it looks cheap.
If you're planning on investing in dividend-paying stocks in 2015, the best investments will be in dividend payers with low payout ratios, high yields, and high returns on capital. These are the qualities most likely to lead to dividend increases, and I feel that Viacom, McCormick, and Campbell Soup will do just that.
Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends McCormick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.