Dividend stocks are often the foundation of 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. Dividends also give investors a painless opportunity to reinvest in a stock, thus boosting future payouts and compounding gains over time.
Yet not all income stocks live 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.
That's right; sometimes the best dividend growth prospects can be observed in megacap companies like networking equipment giant Cisco Systems (CSCO 0.42%).
Cisco has undergone quite the transformation this decade, moving its focus from static servers to dynamic data centers and clouds which are designed to interact with the world around them. But this shift didn't come lightly: Cisco has shed nearly 20,000 jobs since John Chambers took over as CEO. The personnel moves were necessitated by Cisco's need to spend freely on data center and cloud initiatives, earnings accretive acquisitions, and to ensure its profit per share remained relatively steady via share repurchases despite the business volatility, so as not to disappoint investors.
Now, here's the good news: Cisco's organic and inorganic avenues of growth are working for the company once more following its severe cost-cutting. Product revenue rose by 4% in the first quarter of fiscal 2016, with data center and collaboration revenues up 24% and 17%, respectively. The company also delivered strong growth from its wireless and security franchises, aided by the 2013 acquisition of Sourcefire for $2.7 billion. Sourcefire, one of the more prominent cyber-security solutions providers, has proven to be a smart buy that's helped diversify Cisco's product line.
What really makes Cisco tick is its practically unmatchable cash flow, which has topped $11 billion in each of the past three years. Cisco's dominant market share in networking equipment (as well as the expectations that consumer and enterprise data demands will only continue to increase) affords it generally strong pricing power, which in turn leads to healthy margins. This cash flow is the primary reason why Cisco's dividend is a candidate to double. Looking ahead, I could envision its $0.84 annual payout turning into a $1.68 per share annual payout over the next decade as long as it maintains a mid-to-high single-digit percentage EPS growth rate.
Long story short, expect Cisco to remain a superior dividend stock in the tech sector.
J.B. Hunt Transport Services
How's this for irony: Trucking company J.B. Hunt Transport Services (JBHT -0.06%) ended the year near its 52-week low as oil prices continue to tumble.
On the surface you'd think that lower prices at the pump would be great for any company involved in transportation. Airlines, for instance, have watched their costs tumble and their margins soar as jet fuel costs decline. Trucking companies like J.B. Hunt haven't been so lucky. The declines in their fuel surcharges have more than outweighed the positives of load growth in intermodal and dedicated contract services, as well as an increase in capacity in its trucking segment for J.B. Hunt. In other words, trucking companies are struggling to pass high-margin fuel surcharges onto their customers, which is hurting their top-line growth. The bright side for J.B. Hunt and its peers is that oil's dip is more than likely not a long-term correction, which suggests that better pricing power could be around the corner.
Furthermore, an investment in J.B. Hunt today could wind up paying long-tail dividends down the road. For example, during J.B. Hunt's investor day, among the risks discussed for the company were the expenses associated with technology upgrades. However, spending more now on efficiency improvements and capacity expansion could well lead to significant margin expansion by or before the end of the decade. Patient investors will be able to look past the minute near-term margin erosion and observe how business streamlining and tractor utilization improvements could go a long way to boosting profits over the long term.
Looking down the road, J.B. Hunt's EPS is forecast to grow from a reported $3.16 in 2014 to an estimated $5.45 by 2018, yet the company is currently paying out just $0.84 annually for a yield of 1.2%. Keeping in mind that trucking is a highly capital-intensive business (meaning J.B. Hunt likely won't divert too much of its cash flow to a dividend), I would suggest that J.B. Hunt could consider doubling its payout sometime in the next five to 10 years.
Teva Pharmaceutical Industries
Last, but not least, I'd encourage you to look toward another giant in the pharmaceutical sector: Teva Pharmaceutical Industries (TEVA -0.09%).
Teva and its shareholders have had a wild past two years, mainly as a result of the back-and-forth battle over multiple sclerosis drug Copaxone. Teva has been fighting generic drug developers tooth and nail to extend the exclusivity of the blockbuster drug, which at one point accounted for around a fifth of its annual revenue. The positive news for Teva is that the courts have acted in its favor, keeping generic Copaxone entrants on the sidelines for as long as possible. Additionally, Copaxone's new extended-release formulation gives its existing customers another reason not to switch to a lower-cost generic.
But what makes Teva so special is that it's a hybrid drug company – it nets similar amount of revenue from both its branded and generic drug divisions. Attacking the market from a dual viewpoint affords Teva the opportunity to generate huge margins from its branded drug segment, while also sheltering itself from inevitable patent losses with its generic franchise. It also doesn't hurt that patent expirations give generic drug developers a mile-long runway of new therapies that can be brought to market.
The transformative deal that should shape Teva's future is its $40.5 billion purchase of Allergan's (AGN) generic drug business. The roughly 1,000 compounds in Allergan's generic portfolio will be combined with the more than 1,000 molecules in Teva's generic product portfolio to create an absolute generic giant. Based on data from EvaluatePharma via The Wall Street Journal, we're looking at $15.7 billion in combined generic drug sales from 2014 between Teva and Allergan.
As we look ahead, Teva is expected to grow its annual EPS from around $5 per share to nearly $7 between 2014 and 2018. Currently paying a $1.36 annualized dividend, it's not unreasonable to expect Teva to boost its payout to $2.72 or higher in the coming years. The company has demonstrated a rich history of dividend growth over the past decade, so as long as it can keep its debt at reasonable levels, investors may receive substantially juicier payouts.