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, but 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.
When looking for companies that could offer superior dividend income, the first stop for many investors is the financial sector. Banks have a strong tendency to generate profits under even the toughest economic conditions, which is why income investors may want to give regional bank SunTrust Banks (NYSE:STI) a closer look.
Like most banks, SunTrust is battling two major issues. First, it's having to overcome the possibility that the Federal Reserve is going to hold off on hiking rates as the U.S. economy struggles to move forward. Banks were counting on interest rate hikes to boost their net interest margins, so this is certainly disappointing. The other issue would be SunTrust's energy loan exposure. SunTrust, the 11th largest bank in the U.S., operates primarily in the Southeast, which is near a hotbed of energy activity in the Gulf of Mexico.
On the bright side, as of the end of the fourth quarter the bank's nonperforming loans only represented 0.49% of total loans, even after an increase in nonperforming energy loans. Net charge-offs represent an even more minuscule 0.24%, or $83 million, for the fourth quarter. This was actually down from $94 million in Q4 2014. In other words, SunTrust's loan portfolio is still in pretty good shape, even with crude well off its recent highs.
SunTrust is also excelling in the bread and butter components of banking: loans and deposits. Deposit growth for consumer and commercial deposits rose 8% year-over-year to $148.2 billion, primarily helped by NOW account balances, which are for state and local governments as well as nonprofit organizations. Average performing loans grew by 2% year-over-year to $134.7 billion, largely due to commercial and industrial loan growth. Altogether, this solid performance allowed SunTrust to push its full-year EPS higher by 11% in 2015.
Currently, SunTrust is paying its shareholders $0.96 annually, which works out to a decent 2.7% yield. However, it's on track for nearly $4 in EPS by 2018. Although it's been supplementing its shareholder yield with stock buybacks, it seems reasonable that SunTrust could double its dividend over the course of the next decade (or less).
Magic Software Enterprises
Sometimes the most intriguing growth and dividend stocks can be found in the small-cap and micro-cap arena. This is why dividend seekers should really consider giving mobile and cloud-enabled software and application firm Magic Software Enterprises (NASDAQ:MGIC) their full attention.
For Magic Software, the biggest obstacle is going to be its size. At just shy of a $300 million valuation, and sporting $77 million in cash, cash equivalents, and short-term investments on its balance sheet, it's absolutely no match for cloud-based industry giants, which can easily outspend Magic Software. Thus, Magic Software really relies on innovation, business relationships, and its long-term vision to drive its business.
As noted above, however, the company may be relatively small, but it's in excellent financial shape. No debt, $77 million in cash, cash equivalents, and short-term investments on its balance sheet, and it's actively looking to boost its product offerings through mergers and acquisitions. In 2011 it gobbled up BluePhoenix's AppBuilder for $13.5 million, which is an enterprise application that expanded Magic's reach in Europe and Asia. In 2013, it acquired Allstates Technical Services for $10 million to boost its consulting and staffing solutions operations for IT and telecom. Having no debt and a healthy cash balance gives Magic plenty of pathways to grow its business.
We're also looking at a business that's dependent on the bread and butter of growth for enterprises: mobile and cloud-computing. Magic Software's innovations are at the cutting edge of enterprise growth, and we're seeing this translate into top- and bottom-line advancement. In the fourth quarter, excluding the negative impact of currency fluctuations, Magic Software saw sales growth of 15% to a record $49.1 million. For the full year, sales jumped 13% to $185 million. Adjusted profits, when looked at on a constant currency basis, grew 21%.
Right now Magic Software is paying out a semi-annual dividend of $0.09 per share, which works out to a 2.7% yield. With Wall Street's consensus looking like $0.77 in EPS by 2017, it's quite reasonable that this growing and debt-free tech company could reward investors with a doubling of its dividend.
Lastly, if dividend investors are looking to take a big bite out of an income stock, they may want to grab their knife, fork, and a plate and head to their local Domino's Pizza (NYSE:DPZ).
Domino's is really an interesting case. Roughly seven years ago the company's domestic business was struggling -- and management knew it. The company went down an interesting path, choosing to take the mea culpa route of blaming its food for its struggles. This was a risky strategy, but it's paid off nicely for Domino's ever since.
After revamping its recipes and listening to its customers, Domino's was listed as the pizza chain that consumers are most loyal to according to Brand Keys' Customer Loyalty Engagement Index for 2016. Loyalty is difficult to come by in the pizza industry, but it means that Domino's can count on its loyal customers to buy its products regardless of whether they're on sale or not, as well as refer their friends and family to try new products. Stepping off the pedestal was the best thing that could have happened for Domino's in the late 2000s, and it shows in the company's results.
In Domino's fourth-quarter results, announced in late February, we learned that domestic same-store sales grew 10.7% from the prior-year period, and 12% for the full year. Additionally, international same-store sales rose 7.8% for the full year, and grew for the 88th consecutive quarter (that's 22 years -- and no, that's not a typo). Domino's is expanding, it's keeping its customers loyal, and it's engaging with them via special offers and through social media.
The company's 1.2% yield may not look like much now, but that's merely a reflection of its rising share price. With its full-year EPS estimated to crest $5 by 2017, it seems likely that a series of dividend hikes could be in order, eventually leading to a dividend double over the next 5-to-10 years, in my best guess.
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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