Dividend stocks can be the foundation of a great retirement portfolio. Not only do dividend payments put money in your pocket, which can help hedge against any dips 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. Using 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.
Up first this week is discount retail chain Big Lots (NYSE:BIG), which is currently paying out 2% annually, or $0.76 per year.
Big Lots has had its fair share of issues throughout the years. Most notably, Big Lots' venture north of the border into Canada proved to be a monumental failure. Big Lots found the sledding tough against established warehouse retailers like Wal-Mart (NYSE:WMT), and made the decision in late 2013 to close all of its Canadian retail locations. Such a move isn't conducted at the flip of switch, meaning Big Lots and its shareholders have been feeling the effects of this reorganization for years.
The good news is that Big Lots' transformation is now in the rearview mirror, and the company is benefiting from a number of catalysts. As we can see from Big Lots' third-quarter report in December, comparable-store sales for stores open at least 15 months rose 2.6%, marking the seventh consecutive quarter of comparable-store sales growth for the company. Big Lots also upped the lower-end of its adjusted EPS range in its Q3 press release.
What's working for Big Lots? Look no further than the redesign of its food departments, which are more inviting to consumers and allow the company to carry more in-demand brand-name products. The other big catalyst has been Big Lots' focus on furniture financing. Low lending rates and historically low delinquency rates among consumers have fueled furniture purchases, like mattresses, and helped boost the company's comparable-store sales.
It's also possible that recent sales weakness at Wal-Mart could be translating into growth from Big Lots, but we'd need confirmation on that from Big Lots' management team. Wal-Mart reported last week that it now expects flat sales growth in fiscal 2017 after previously forecasting growth of 3% to 4%. Big Lots is catering to the same cost-conscious customer, but it often loses to Wal-Mart's variety. It's possible we're seeing a small shift here that's favoring Big Lots.
With $3.29 in EPS expected by fiscal 2017, it wouldn't be out of the question to expect Big Lots to boost its annual dividend above $1.50 over the next 5-to-10 years. Slow growth businesses like Big Lots can benefit in a big way by attracting long-term investors, and a juicier dividend yield would certainly help the cause.
Next, we'll take a casual stroll over to the financial sector, where property and casualty insurer Travelers Cos. (NYSE:TRV) is looking ripe for some fairly substantial dividend growth.
Whereas most stocks have had a dismal trailing 52-week performance, Travelers shares are actually up 1%. The fact that Travelers is up is pretty phenomenal considering it's been dealing with seven years of exceptionally low lending rates. Low interest rates aren't great news for insurers because they invest in short-tern, safe, interest-based assets with their premium float. With rates still low, Travelers' net investment income has been capped.
However, investors have been able to overlook this minor flaw as Travelers has excelled in so many other aspects. Just days ago Travelers reported a record full-year adjusted net profit of $10.88 per share, and an impressive combined ratio -- a measure of margin for insurers, where a number below 100 signifies an underwriting profit -- of 86.6%. Travelers' book value also grew by 3% during fiscal 2015.
What's working? Insurers like Travelers, which insure property, people, and even cyber-risks, benefited from a quarter with minimal catastrophe claims. Fewer claims means the company is able to keep more of its premium as profit, equating to an improved combined ratio.
Another key to success for Travelers has been its ability to retain profitable clients while taking "appropriate measures to improve profitability" on accounts that aren't profitable. In other words, Travelers is focusing on cost-maintenance in this low-yield environment. Aside from dropping unprofitable policyholders, the company is also benefiting from innovative new products. Its Quantum Auto 2.0 plans, which debuted in 2013, allow for more segmented pricing options for personal drivers, which has in turn led to it being more competitive in the auto insurance segment.
As one of the world's largest insurers and brand-names, Travelers is probably capable of growing its EPS in the low-to-mid single-digit percentage range annually, yet it's paying out less than 25% of its earnings to shareholders as a dividend. It wouldn't take much to shift some of its share repurchases to dividend payments, effectively doubling its dividend to nearly $5 annually within the next 5-to-10 years.
To wrap up, I'd encourage income-seeking investors to jaunt over to the industrial sector and consider taking a closer look at Toro (NYSE:TTC), a company that manufactures a variety of outdoor equipment for commercial and residential purposes (think lawn equipment and ATVs).
What are the downsides of owning a company like Toro? The biggest concern is that Toro is a highly cyclical company. If the U.S. hits a recession, it's likely that commercial and residential customers will hold off on discretionary equipment purchases. The other potential issue here is unfavorable weather. There's not a lot Toro can do about the weather, so once in a while investors simply have to deal with the unpredictability of Mother Nature.
But if you can overlook both of these generally short-term concerns, then you'll likely see a company geared to succeed over the long-run.
Toro reported its fiscal first-quarter results last week, and as expected they didn't disappoint. Although sales of the company's winterized products languished (until recently), sales of zero-turn riding mowers and contracted landscaping equipment have been pushing sales and profits higher. In a way, you could say that Toro's business segments are somewhat hedged to benefit no matter what Mother Nature throws its way. As icing on the cake, Toro also increased its full-year guidance above estimates.
Investors shouldn't overlook the fact that low lending rates, while hurting insurers like Travelers, are helping companies like Toro. Access to cheap capital is giving commercial customers an incentive to buy equipment and expand. Since its professional segment comprises about 70% of total revenue, this is a major growth catalyst for Toro since it doesn't appear that lending rates will be rising anytime soon.
Toro is currently sporting an annual payout of $1.20, which is good enough for a 1.6% yield. Taking into account Wall Street's prognostication that Toro could top $5 in annual EPS by 2018, and riding the belief that innovation will continue to drive Toro's long-term growth, a doubling in the company's dividend payout over the next decade doesn't seem like too much to ask.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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