Dividend stocks can be the foundation of a great retirement portfolio. Not only do the payments put money in your pocket, which can help hedge against any dips in the stock market, they're usually a sign of a financially sound company. Dividends also give investors a painless opportunity to reinvest in a stock, thus compounding gains over time.
However, not all income stocks live up to their full potential. Using the payout ratio -- i.e., the percentage of profits a company returns to its shareholders as dividends -- 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.
We'll begin this week by looking at payment processing giant MasterCard (NYSE:MA), which may not look like much on the surface with a 0.9% yield, but could well turn into a dividend juggernaut over the next decade.
What's working in MasterCard's favor are three primary factors: expansion, barriers to entry, and exposure.
In terms of expansion, approximately 85% of the world's transactions are still be conducted in cash. This means MasterCard, and its main rival, Visa (NYSE:V), have a long-tail opportunity to capture cash transactions and turn them into credit or debit transactions. MasterCard and Visa are just scratching the surface of the market in regions such as Africa, the Middle East, and Southeast Asia, which suggests that many years of strong growth still lie ahead.
Secondly, the barriers to entry are pretty sizable in the payment processing market. You pretty much have MasterCard, Visa, Discover Financial Services and American Express. Entering the space requires a lot of merchant partners, and acquiring those in quantity isn't something that happens overnight. Moreover, creating a processing service requires infrastructure which can take a lot of capital to put into place. This alone keeps MasterCard's competition down to just a handful of companies.
Third, MasterCard has minimal downside exposure. It is counting on a rise in global spending and transactions to boost its profitability, but unlike some of its peers, it's not a lender. (Visa doesn't lend either.) Thus, if credit delinquency rates rise, MasterCard will feel it far less than AmEx or Discover would, since they serve as both lenders and payment facilitators.
In 2015, MasterCard generated $3.9 billion in income, a 15% constant currency increase from 2014 , and its quarterly dividend payment has risen by 1,167% since early 2012, far outpacing rival Visa. Don't let its current low yield fool you -- this looks to be an income giant in the making.
Next, I'd suggest income-seeking investors take a casual stroll over to the technology sector, where wafer fabrication and semiconductor equipment service provider Lam Research (NASDAQ:LRCX) awaits.
Arguably the most exciting catalyst for Lam right now is its acquisition of KLA-Tencor (NASDAQ:KLAC) for $10.6 billion in a cash and stock offer. The deal, which has been approved by shareholders and is expected to close by mid-2016, will allow the combined company to control 42% of the wafer fabrication equipment market, including front-end wafer processing and back-end wafer-level packaging. Higher market share should mean better pricing power, a potentially more diverse customer base including an even bigger role with Samsung, and an estimated $600 million in annual incremental revenue by 2020. The deal should also result in $250 million in annualized cost savings within two years.
Another key point is that Lam Research, post-merger, will be an even healthier cyclical company. Although this means Lam is bound to deal with inevitable downturns in the U.S. and global economies, history has shown that global markets are in expansion mode for a far greater proportion of time than they are in recession. Thus, while hiccups might be a normal part of owning stock in semiconductor equipment makers like Lam, they rarely last for extended periods.
Lam ended the year with $4.7 billion in cash, some of which will be used to fund its merger with KLA-Tencor. But this cash also acts as a backstop to ease it those aforementioned rough periods, as well as a buoy for dividend growth. It's currently paying out just $1.20 per share annually, but is expected to deliver as much as $7 in EPS in 2017 (post-merger),so a series of dividend hikes to perhaps $2.50-plus seems quite plausible.
Last, but not least, income investors may want to consider stepping on the gas with luxury sports car manufacturer Ferrari (NYSE:RACE). Despite it being a newly traded company following its spinoff from Fiat Chrysler Automobiles last year, its board in February decided to award shareholders an annual dividend of nearly $0.51 per share, which is good enough for a 1.1% yield.
What makes Ferrari such an intriguing stock? Aside from the prestige that comes with the brand, Ferrari's target audience makes it attractive. Let's face it, you're not going to find a new Ferrari for a five-digit price tag. Ferraris are priced for the well-to-do, and orders can be taken months in advance. The wealthy individuals who buy Ferraris are often not as shaken by recessions or economic downturns as working-class citizens. In short, Ferrari has a really good shot of growing regardless of how well or poorly the global economy is performing.
Ferrari also benefits from exclusivity. Keeping a cap on how many vehicles it produces each year gives the luxury automaker incredible pricing power, and it also keeps the company outside the realm of the United States' fuel-economy rules, as Foolish auto expert John Rosevear noted back in October. Ferrari still has room to expand production somewhat, but it'll allow its vehicle pricing to handle the bulk of growth.
Looking ahead, Wall Street foresees Ferrari nearing $2 in annual EPS by 2018. In my mind, as long as Ferrari's growth remains consistent and its expenses are under control, its $0.51 annual dividend has a shot at doubling over the next decade, or less.
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.
The Motley Fool owns shares of and recommends MasterCard and Visa. It also recommends American Express. 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.
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