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.
Bank of America
Most everyone understands Bank of America's story by now and its fall from grace during the mortgage meltdown. By mid-2014, Bank of America had paid $61.2 billion in settlements to the U.S. Justice Department associated with the mortgage meltdown, mostly a result of its Countrywide Financial acquisition. Adding fuel to the fire, net interest margins throughout the banking industry have been depressed by seven-plus years of historically low lending rates, precipitated by an accommodative Federal Reserve that's been looking to reignite economic growth in the U.S. This has translated into a tame 1.4% dividend yield for one of America's biggest, and most recognizable, money center banks.
However, it's my contention that a string of dividend increases could be right around the corner for B of A, leading to a possible doubling of its dividend within the next five years.
The biggest catalyst for Bank of America is that it's finally putting its legal settlements in the rearview mirror. A reduced legal expense budget is allowing investors to get as close to an apples-to-apples operating comparison of Bank of America's core businesses as they've seen in a decade. In the first quarter, noninterest expenses fell $1 billion year-over-year to $14.8 billion, all while total deposits and loans grew by $64.1 billion and $28.4 billion, respectively. Not having to set aside billions for settlements likely means a big boost in upcoming profitability.
Another key point is that lending rates are likely to normalize at some point in the future. I have no crystal ball and couldn't tell you when exactly that's going to happen, but it's clear that the Federal Reserve would prefer its fed funds target rate be closer to 2%-3% in the long-term. This would imply that net interest margins can pretty much only go up from here, thus boosting profitability and giving Bank of America extra capital to deploy to its shareholders.
Fundamentally Bank of America is attractive, too. It's trading below its tangible book value of $16.17, and its annual payout of $0.20 represents a minuscule 15% payout ratio. If lending rates rise by 2% over the coming three years (as a hypothetical example), Bank of America's annual EPS could push above $2, making a move to $0.40 in annual payouts seem very reasonable.
Sometimes investing in dividend stocks can be as simple as A-B-C -- as in AmerisourceBergen's (ABC -0.32%) ticker.
Like B of A, AmerisourceBergen has had its fair share of issues recently. During the branded, generic, and over-the-counter drug distributor's first-quarter report, we learned that it was lowering its full-year EPS outlook to a range of $5.44-$5.54, down from a prior forecast of $5.73-$5.83. The company also projected full-year sales growth of 8%, down slightly from the 9% growth that had been previously forecasted. The big culprit for AmerisourceBergen is generic drug price deflation. Additionally, internal initiatives to boost its independent retail segment and promote PRxO Generics failed to meet expectations.
Although AmerisourceBergen is letting some air out of its tires with its updated guidance, there's still plenty of tread left to motor on. For instance, an IMS Health forecast released in November predicts that generic drug use in the U.S. will increase from an already high 88% of prescriptions written in 2015 to between 91% and 92% by 2020. IMS anticipates that price increases will remain steady in the 5% to 7% range between 2015 and 2020, which should have a generally positive impact on generic pricing, and thus AmerisourceBergen's margins.
Investors should also be thrilled that AmerisourceBergen locked up its biggest pharmacy retail customer, Walgreens Boots Alliance, for another three years. Just because there's a small amount of pricing disruption in generic pricing doesn't mean the model is broken. With Walgreens retained, and a large pharmacy-benefit manager secured for another year, AmerisourceBergen can focus on its growth initiatives rather than worrying about its cash flow.
We're also talking about a company with a solid history of putting shareholders first. AmerisourceBergen has authorized up to $750 million in share buybacks, which can have the effect of boosting EPS and making a company's valuation look more attractive, and with the exception of a minor hiccup during the Great Recession, the company has regularly boosted its dividend payment since 2006.
Currently paying $1.36 annually, which is good enough for a 1.6% yield, but expected by Wall Street to be generating $7+ in annual EPS by the end of the decade, a doubling in its dividend seems quite doable within the next 5-to-10 years.
Finally, income investors looking for a fashionably good deal might want to consider digging into Ralph Lauren (RL -0.89%), the wholesaler, retailer, and licensor behind the Polo Ralph Lauren, Chaps, and Black Label collections, to name a few.
Like the other two companies mentioned above, Ralph Lauren has hit a little bit of a bump in the road recently. Its latest quarterly results showed a drop in adjusted EPS to $0.88 from $1.41 in the prior-year period, primarily the result of a decline in wholesale revenue and a response to higher inventories, which led to discounting. Retailers are certainly not perfect, and their product choices can, from time to time, lead to discounting to clear out merchandise. This appears to be exactly what happened to Ralph Lauren during the latter half of its fiscal 2016. But minor hiccup aside, there's a lot to like as a long-term investor.
For starters, Ralph Lauren's brand image is a selling point. In 2015, Interbrand ranked it as the 91st most valuable global brand (and we're not talking just apparel), Tenet Partners and CoreBrand listed Ralph Lauren as 59th in its 100 most powerful brands, and L2 ThinkTank listed Ralph Lauren as No. 3 among fashion brands ranked by Digital IQ Score. In simpler terms, consumers around the globe are familiar with the Ralph Lauren brand, and they tend to have an affinity for buying branded merchandise, which would seem to imply long-term success for the brand.
Ralph Lauren is also focused on reaching a global audience in China, one that's hungry for affordable luxury brand names, and the company is simultaneously expanding its e-commerce business. Even though sales for Q4 2016 fell 1% year-over-year, e-commerce revenue grew by the mid-single-digits during the quarter, demonstrating that convenience is still going to be key to growing its business.
Cost-cutting and efficiency improvements are also boosting Ralph Lauren's bottom-line. Its global reorganization plan is on pace to save the company $125 million annually, up from a prior forecast of $110 million, largely due to improved supply chain management and lower product counts, which are keeping inventory levels manageable.
Ralph Lauren is currently paying $2 to shareholders annually, good enough for a 2.3% yield, but is expected to generate upwards of $8+ in adjusted EPS by fiscal 2019. Given its strong image pull and opportunity in China, a doubling of its dividend within a decade appears likely.