Dividend stocks are often the foundation for a great retirement portfolio. Dividend payments not only put money in your pocket, which can help hedge against any downward move in the stock market, but they're usually a sign of a financially sound company. Dividend payments also give investors the opportunity to reinvest into more shares of stock, thus boosting future dividend payments and compounding gains over time.
Yet not all income stocks are living up to their full potential. Utilizing the payout ratio, or the percentage of profits a company returns in the form of a dividend to its shareholders, we can get a good bead on whether a company has room to increase its dividend. Ideally, we like to see healthy payout ratios between 50% and 75%. Here are three income stocks with payout ratios currently below 50% that could potentially double their dividends.
Baxter International (BAX 1.28%)
Sometimes the smartest way to attract long-term buy-and-hold investors is to offer an attractive dividend, which is what I believe medical device maker Baxter International may want to consider following its spinoff of rare-disease drugmaker Baxalta (NYSE: BXLT).
In Baxter International's most recent quarter, the company announced that worldwide sales shrank 8% to $2.5 billion. However, this included the negative effects of currency translation. If we're doing a strictly apples-to-apples comparison, Baxter global sales inched forward by 2% in the third quarter, with growth in international markets providing the bulk of the spark.
Boosting Baxter's dividend here would make sense for two reasons. First, the company's growth rate is a lot slower without Baxalta's high-priced rare-disease drugs in its back pocket. Although the company generated $223 million in after-tax benefits related to the Baxalta spinoff this summer, it's likely facing slow growth prospects in the near term as Europe deals with its debt issues and competition in the U.S. intensifies. Placing an emphasis on cash returns and cost-cutting would be a good way of buoying its EPS and rewarding existing shareholders with a dividend yield above the broad-market S&P 500.
The other reason Baxter could consider this is because it has long-tail growth on the horizon. The retirement of baby boomers in the U.S., and the improving ease of access to medical care in emerging markets, should bring an influx of patients into hospitals and long-term care facilities in the coming decades. Additionally, improvements in pharmaceuticals may continue lengthening people's lives, providing even more time for Baxter to make its mark on improving quality of life.
With Baxter's EPS on track to grow from an estimated $1.26 in 2015 to $1.91 by 2018, it seems reasonable to me that Baxter could double its annual payout from $0.46 to $0.92.
Alaska Air (ALK -1.85%)
If you're looking for a sector with an abundance of profits that could begin doling out some hefty dividends in the near future, I'd look no further than airlines. As for specific stocks, Alaska Air has my full and undivided attention.
Alaska Air is expected to grow like wildfire based on Wall Street's estimates. After reporting $4.18 in EPS in 2014, Wall Street anticipates Alaska will grow this to roughly $9 in full-year EPS by 2018. Some of this growth is based on market dynamics that include more capacity and higher demand for travel by consumers. For nearly two years now Alaska's capacity and revenue growth has handily outpaced its larger peers, and it's giving the company every reason to continue spending on new planes and potentially tinkering with the idea of adding more routes.
The other component here is that fuel prices have been way down due to the precipitous drop in oil prices. It remains to be seen if oil prices will remain low for a long period of time, but the Federal Reserve's actions, which have kept lending rates near record lows since 2009, have allowed airlines like Alaska access to capital at a reasonably cheap cost. This cheap capital has allowed Alaska to add newer and more fuel-efficient planes to its fleet, helping to partially neutralize higher oil prices if and when they come back.
The X-factor, though, is the love Alaska is shown by consumers. J.D. Power has anointed Alaska its top airline by customer satisfaction every year since 2008. Alaska also won top honors for satisfaction with its loyalty program for the second consecutive year. What this demonstrates is that Alaska is doing a good job of retaining its customer base, which ultimately could help improve its pricing power over the long term.
Paying just $0.80 annually -- but keeping in mind that the sector itself is very capital-intensive -- it looks reasonable that Alaska could easily double its dividend.
Torchmark (GL -0.36%)
Finally, I'd encourage income investors to take a good look at Torchmark, a company that underwrites life insurance and various healthcare policies, including long-term care, cancer care, and Medicare Part D.
According to Torchmark's third-quarter forecast the company is on pace to deliver $4.25 to $4.55 in EPS next year, which is a little lower than it previously forecasted due to higher Medicare Part D expenses and direct response claims. However, Torchmark is only paying out $0.54 per year, leaving plenty of room for additional dividend growth.
One factor working in Torchmark's favor is the expectation that the Fed will begin raising lending rates soon. Insurance companies are often sitting on large pools of money known as their float, which is money taken in from premiums but not paid out as claims. This money is often invested in interest-bearing, safe investments. Even small increases of 25 basis points in the federal funds target rate could mean substantially more in investment income for insurers like Torchmark. In Q3 2015, Torchmark generated $193.2 million in net investment income, ultimately netting $54.1 million in profit from its investment portfolio once interest on net policy liabilities and interest on debt were paid.
Investors should also understand that insurers price their products for success. The majority of Torchmark's premium underwriting and profits (about 70%) is derived from its life insurance business. Things do happen and insurers such as Torchmark will suffer catastrophes that require payouts from time to time. But, insurers also typically have the ability to raise their prices at a rate that outpaces inflation and ensures their long-term survival. A catastrophe gives an insurer plenty of reason to raise its premium prices to recoup near-term losses, but insurers can also modestly raise pricing during periods of lower payouts with the reasoning that it's saving up for the next inevitable catastrophe. It's a business model that's designed for long-term success.
In my opinion, once lending rates begin to rise Torchmark could easily begin raising its dividend to $1 annually, or higher.