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 also 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.
This week we'll begin with a company known for fast food that's trying its best to shed the fast-food label with today's younger crowd -- none other than Wendy's (NASDAQ:WEN).
Like most national fast-food chains, Wendy's faces a monstrous amount of competition. On one hand it's competing against its peers that are trying to offer superior variety with their menu or that are undercutting Wendy's on price. On the other side of the aisle we have fast-casual restaurants, such as Panera Bread, that seek to capitalize on the family atmosphere with a quick turnover. Wendy's wants to find itself somewhere in the middle.
How does it get there? The answer can be found in marketing to millennials, which comprise around a quarter of the company's business. For instance, Wendy's trademark spokeswoman in its new commercial campaigns is a millennial, its new menu items caters to a more health-conscious millennial consumer, and it's taken to social media by storm to meet millennials on their level. If Wendy's can present the image of being in touch with the wants and needs of millennials, it could see long-tail market share gains in its core operations.
The bigger growth driver of late for Wendy's has been its strategic initiative to sell company-owned restaurants to franchisees. Between 2013 and 2015, Wendy's sold 826 of its restaurants to franchisees. Although doing this could adversely affect Wendy's recognized revenue, it's getting a much higher bang for its buck, as is evidenced by its 260-basis-point improvement in operating margin to 14.7% in full year 2015. The franchise model also shifts some of the development and expansion costs to its franchisees, helping to lower Wendy's direct cost burden.
Currently, Wendy's is paying out $0.24 annually, which works out to a 2.2% yield. Considering that Wall Street expects Wendy's full-year EPS to double between 2015 and 2019, and factoring in the company's expanding margins, it's not out of the question to expect Wendy's dividend to perhaps double over the next five to 10 years.
Next we'll look at only the largest health insurer in the United States, UnitedHealth Group (NYSE:UNH).
UnitedHealth Group has one primary concern as a health-benefits provider: ensuring it charges enough in premium to its members to cover their medical expenses. Even for a company as experienced as UnitedHealth Group, flubs happen. UnitedHealth announced earlier this year that it expects to lose nearly $1 billion, cumulatively, on individual Obamacare plans between 2015 and 2016. In fact, UnitedHealth may pull out of the Obamacare exchanges completely by next year following these tough losses. But the good news for shareholders is that Obamacare represents a small snippet of what this benefits provider is all about.
To begin with, UnitedHealth gets more than 30% of its annual revenue from its Medicare Advantage, Medicare supplement, and Medicare Part D plans. Medicare currently covers 48 million people, most of which are seniors aged 65 and up. Original Medicare is designed to cover 80% of eligible outpatient costs, but it leaves the consumer on the hook for the remaining 20%. What UnitedHealth provides are ways to fill those gaps so the consumer doesn't have to pay as much out of pocket, or to provide a complete alternative to Medicare via the Medicare Advantage (MA) plan. MA plan selection has more than doubled from 13% of eligible patients in 2005 to 30% as of 2015. With baby boomers reaching age 65 in greater numbers, UnitedHealth's Medicare business is expected to thrive.
UnitedHealth's subsidiary Optum is also seeing benefits from this aging population trend. Its healthcare delivery business pushed OptumHealth revenues up 26% year over year in the fourth quarter, and the company wound up serving 15 million more consumers than in the prior-year period. OptumRx also delivered strong growth with a near-doubling in revenue and 36% script growth in full year 2015 to 778 million adjusted scripts. This year OptumRx is expected to fulfill 1 billion adjusted scripts.
At the moment UnitedHealth is paying $2 annually, good enough for a 1.6% yield. However, by 2018 UnitedHealth could be pushing $10 in full-year EPS, which appears to be more than enough of a buffer to consider raising its dividend payment in a big way over the coming five to 10 years.
Last, but not least, dividend investors looking for substantive income and share-price growth may want to dig into Huntington Bancshares (NASDAQ:HBAN), a regional bank operating in the Ohio River Valley.
As you may already be well aware, banks are facing a number of hurdles. Weakened U.S. growth has pushed the Federal Reserve to put its interest-rate hikes on hold for the time being. While potentially great for the consumer looking for a loan, a low-yield environment is bad for banks' net interest margins. Additionally, banks are dealing with the possibility of worsening credit quality in the energy sector. As for Huntington Bancshares, it's business as usual.
Loan and deposit growth, a.k.a. the bread and butter of banking, once again led the way in fiscal 2015 for Huntington. Average loan and lease growth expanded 7% to $3.2 billion, driven primarily by a 14% increase in automobile loans and an 8% increase in commercial and industrial loans. Remember, even though low lending rates hurt net interest margin, it also encourages businesses to expand, as is evidence by the 8% increase in C&I loans. Deposit growth vaulted higher by 9% to $4 billion, including a 17% increase in noninterest bearing deposits, meaning no cost to Huntington.
Credit quality for Huntington also looks appealing. Net charge-offs as a percentage of average loans and leases fell to 0.18% in 2015 from 0.27% in 2014. Low levels of net charge-offs mean less need to set aside capital for loan losses, and it also allows Huntington Bancshares to use leverage to its advantage.
Currently paying out $0.28 annually, Huntington's 3% yield is already topping the average yield of the S&P 500 -- but it could get better. After reporting $0.81 in full-year EPS in 2015, Wall Street anticipates the company could deliver $1.14 in full-year EPS by 2018. A doubling in its dividend would merely push its payout ratio to around 50%, which seems reasonable and doable over a five- to 10-year period.
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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