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.
IBM (IBM -1.14%)
Keep in mind that one reason dividend yields can rise is because stock prices can fall and make those yields look attractive. That's very much been the case for information technology and services giant IBM, whose share price has tumbled by more than 30% over the trailing two-year period.
What's wrong with IBM? The emergence of the cloud and large data centers left Big Blue on the outside looking in. IBM's had to retool its entire product lineup, moving away from static enterprise software and into new products that emphasize the dynamics of today's business environment. In even plainer terms, it's meant more spending for IBM, and it's meant that weakness from its legacy enterprise business is still outweighing growth from its cloud and data center ventures.
However, I think casting IBM aside because it's in the midst of a transition would be a foolish (with a small "f'" idea. To begin with, IBM is making strong inroads in cloud computing in multiple fields, and not just within technology. IBM, for instance, could deliver strong healthcare growth over the coming decade and beyond. As of the third quarter, IBM tallied $9.4 billion in cloud revenue over the trailing-12-month period, and cloud sales could continue to grow upwards of 30% per year in the near term.
Another important point is that IBM will always have levers at its disposable to improve its margins. At some point its spending on innovation in the near-term to catch up to its peers will abate a bit, allowing for margin improvement. Plus, $13.6 billion in free cash flow over the trailing 12 months is nothing to sneeze at, and it could give it plenty of opportunities to improve shareholder yield via buybacks or dividend increases.
Currently paying $5.20 annually, which is good enough for nearly a 4% yield, and as one of Warren Buffett's top holdings, I could reasonably see IBM doubling its dividend over the next decade to beyond $10 per year. Remember that IBM has had to reorganize its business multiple times before, and it's succeeded each time. If you're patient, I believe you'll be rewarded.
Stanley Black & Decker (SWK -5.40%)
Shareholders of Stanley Black & Decker, a maker of power and hand tools, as well as security systems, have come to the realization that their stock hasn't moved much over the past year. Stanley Black & Decker closed this past weekend at roughly its Nov. 2014 level. But don't let this stagnancy fool you -- this company has the tools (literally) to succeed.
In a recent interview with CNBC, CEO John Lundgren focused on some of the weaknesses the company has recently faced. These include high exposure to foreign exchange vacillations since 47% of its revenue is derived outside the U.S., and some weakness in industrials, likely tied to tightening government spending and weak commodity prices.
Now, let's break down the above comments. First, foreign currency translation really isn't an issue if you're willing to dig below the surface and examine operational demand. Although currency translation affects Stanley Black & Decker's top and bottom lines, it's also beyond the company's control. The smart move is to look at this from an apples-to-apples growth basis, and by doing so, in the third quarter it would show that net volume rose by 5% year over year with an additional 1% improvement in price. I'm not saying completely forget about the impact of foreign currency, but I do suggest looking at the bigger picture, which is Stanley Black & Decker's growing demand and pricing power on a constant currency basis.
As to Lundgen's other point, weakness in industrials can be countered by strength in construction, largely due to lower input prices for materials and historically low lending rates domestically, and a still-strong consumer market. Stanley Black & Decker has a multifaceted approach to growth that bodes well over the long term.
We're also talking about a Dividend Aristocrat here with a 48-year ongoing streak of raising its dividend. Currently paying $2.20 annually, which is good enough for a 2.3% yield, I could certainly foresee a double in its payout being achievable with $8 in annual EPS projected by 2018. Management has often been conservative with its dividend increases, but I could see $4-plus per share in annual dividends paid within the next five to 10 years.
KeyCorp (KEY -0.22%)
Lastly, I'd encourage income-seeking investors to keep their eyes peeled on the banking sector, with specific attention given to KeyCorp, a retail and commercial banking company that also provides investment banking services.
Like most banks, KeyCorp has faced its set of challenges since the Great Recession. Depressed home values and poor credit quality for its loan portfolio led to financial woes early in the decade, and more recently, the weakness in commodity prices has investors concerned about any loans it may have outstanding with energy industry companies. Excuses are aplenty for avoiding big banks, but I believe there are numerous reasons to consider KeyCorp a buy.
To begin with, banks are set to benefit in a big way if the Federal Reserve continues raising interest rates. Historically low lending rates for the past six years have been a boon for the economy and the U.S. consumer, but it's crushed interest-based income for banks and sapped the strength out of their net interest margins. If we even get 100 basis points added back into lending rates over a two-year period, it could have a substantially positive impact on KeyCorp's profits.
Another catalyst is KeyCorp's announced buyout of First Niagara Financial (NASDAQ: FNFG) for $4.1 billion. First Niagara has a huge presence in New York, especially upstate, and the combination of the two banks will create a giant with just shy of $100 billion in deposits and around $135 billion in assets. Presumably, the combination will help eliminate overlapping businesses and result in synergies that boost margins and profits for KeyCorp, while also expanding the reach of its branches further into the Northeast.
At the moment, KeyCorp is paying out $0.30 annually, good enough for a 2.5% yield. But by 2018, once the First Niagara Financial deal begins to pay dividends, KeyCorp's EPS could balloon to $1.40 for the full year. In my opinion, KeyCorp could afford a $0.60 annual payout then, and it's a name you'll want to closely monitor in the banking sector.