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 we're talking about attractive income stocks, there's nowhere better to begin our week other than the financial sector, home of the above-average dividend yield. Specifically, Id direct your attention to retail and commercial Southeastern regional bank BB&T Corp. (NYSE:BBT).
Like most banks, BB&T is facing two struggles at the moment. First, the Federal Reserve has backed off of its plans to increase lending rates in lieu of weaker-than-expected Q4 U.S. GDP growth. Banks rely on rising lending rates to expand their net interest margin, meaning a slowdown in the Fed's charting of lending rate hikes could stymie their near-term growth prospects.
The other issue for BB&T, and most banks for that matter, is the amount of energy loan exposure on the books. Oil and natural gas prices hit 12- and 17-year lows earlier this year, which means many of the exploration and production businesses involved with these commodities could be producing losses and struggling if they're over-levered. Long story short, investors are worried about loan defaults.
Now for the good news: energy comprised only 1.2% of BB&T loan portfolio according to S&P Global Market Intelligence. Even though a higher percentage of its energy portfolio could be considered challenged as of the release of BB&T's Q1 2016 results, it's a small enough percentage of BB&T's loan portfolio to not have a long-term adverse impact on its business model and profitability.
We're also witnessing pretty steady growth in loans and deposits, the bread and butter of profitability for the banking industry. In BB&T's recently reported first-quarter results, average noninterest-bearing deposits grew at a 3.3% annualized rate, while average direct retail loans and average commercial real estate-income producing loans grew at an annualized rate of 7.8% and 6.9%, respectively. BB&T also announced record net interest income (which is amazing considering lending rates are still near record lows), while pushing noninterest expenses down by $52 million from the Q4 2015.
With BB&T's credit quality remaining generally strong, and acquisitions helping BB&T expand its presence throughout the Southeast, I'd opine that its current $1.08 in annual dividend payments (3.1% yield) could be set to double over the next decade.
Metaldyne Performance Group
Next, we'll turn our attention to an industrial supplier of metal castings and parts used by the commercial and industrial vehicle markets, Metaldyne Performance Group (NYSE:MPG).
If the name doesn't ring a bell, you're not alone. Metaldyne Performance only became a publicly traded company in late 2014, and as a low-end midcap with a $1.1 billion valuation and an average volume of just over 100,000 shares per day, it tends to fly under most investors' radars. But, sometimes these under-the-radar companies are exactly what offer the most intriguing growth and income prospects.
In Metaldyne Performance Group's case, its financial results and business outlook both signal it's making all the right moves. For fiscal 2015, net sales grew by 12.2% to $3.05 billion, with gross profit rising by 22% and the company reducing its net debt by $89 million. Long-term debt remains the biggest eyesore with MPG carrying $1.85 billion on its balance sheet, but a regular reduction of nearly $100 million per year seems perfectly doable.
Additionally, MPG is benefiting from a reduction in commodity prices over the past five years. Aluminum prices have dropped from more than $1.20 per pound in 2011 to just $0.74 per pound today, while iron ore prices are down by about two-thirds. Falling commodity prices help reduce MPG's expenses, which can in turn help boost margins. Conversely, you'd expect lower commodity prices to also adversely impact MPG's pricing power, but that's not exactly the case. MPG operates in a niche precision casting space for commercial and industrial vehicles, meaning it likely has more balanced industry exposure relative to what some of its peers are contending with.
And of course we have an opportunity for improved shareholder yield. MPG's board authorized $25 million for share repurchases, and the company is currently paying out $0.09 per quarter in dividends, which works out to a 2.2% yield. Considering that MPG's $1.80 in reported 2015 EPS could grow past $2.40 by 2019, a doubling of its dividend to $0.18 per quarter (or higher) seems like a possibility before the end of the decade.
American Water Works
Finally, I'd encourage income investors to consider water utility American Water Works (NYSE:AWK).
What makes a company like American Water Works so exciting is that it operates in such a boring industry. Yes, I'm fully aware of how odd that sounds, but sometimes the best business models are completely boring on paper. American Water Works provides basic-need services, including water and wastewater services. If you own or rent a home in a region where American Water Works operates, there's a good chance you'll need these services. Furthermore, there's often minimal competition in the regions it operates, leaving the consumer with few choices as to who will provide their water and wastewater services.
Another selling point of American Water Works is that it operates in a regulated industry. A regulated industry can have its downsides in that businesses are at the mercy of local and state governments to approve utility price hikes. Conversely, though, it makes cash flow and profitability extremely predictable. That's important for American Water Works as it'll use its debt and leverage to expand its business organically and inorganically.
That brings us to the next point: inorganic growth. American Water Works is able to channel its predictable operating cash flow from its water service business in 47 states and Canada into acquisitions (often multiple per year) that grow its customer base. Plus, with lending rates remaining low, American Water Works can utilize leverage responsibly to expand its reach.
Since debuting via IPO in 2008, American Water Works has raised its dividend in each and every year. In fact, just days prior it announced another 10% dividend hike to $0.375 per quarter. Considering that its profits are on course to grow by a mid-to-high single-digit percentage each year, a doubling in its dividend over the course of the next decade seems possible.
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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