This is a guest contribution by Bob Ciura of Sure Dividend.
Investors looking for the strongest dividend growth stocks should focus on the Dividend Aristocrats. In order to become a Dividend Aristocrat, a company must be a component of the S&P 500 Index, and have raised its dividend for at least 25 consecutive years, among other criteria. There are currently just 57 Dividend Aristocrats in the S&P 500 Index.
The following three Dividend Aristocrats offer the combination of a market-beating dividend yield, low stock valuation, and strong earnings growth potential. As a result, each stock earns a buy recommendation from Sure Dividend, as they have the lowest level of dividend risk and high expected returns over the next five years.
1. AT&T Inc. (T)
Telecommunications giant AT&T is a unique Dividend Aristocrat, primarily because of its very high yield above 6%. AT&T can afford such a high dividend payout to investors, thanks to its diversified business model and prodigious cash flow. AT&T has over 100 million customers in the U.S. and a significant presence in Latin America. The company provides a wide range of telecom services, including wireless, broadband, and pay-television. AT&T generates more than $170 billion in annual revenue and the stock has a market capitalization of $238 billion.
In late April, AT&T reported first-quarter financial results. Revenue of $44.8 billion missed analyst estimates by $270 million, while adjusted earnings-per-share of $0.86 matched analyst expectations. Revenue increased 18% for the first quarter, primarily driven by the Time Warner acquisition that closed in June 2018. Adjusted earnings-per-share of $0.86 rose 1.2% from the same quarter a year ago. Revenue growth was heavily offset by rising expenses and a higher share count. AT&T’s core mobility segment grew revenue by 2.9% for the quarter, thanks to 179,000 net postpaid smartphone customer additions during the quarter.
AT&T generates a great deal of free cash flow, which will allow the company to accomplish multiple financial objectives. In addition to reinvesting in future growth efforts, AT&T can reward shareholders with dividends, and also pay down debt. The company paid off over $2 billion of debt in the first quarter, ending the period with a net-debt-to-adjusted-EBITDA ratio of 2.8x. AT&T will pursue additional debt reduction in part through asset sales, such as the recent deals to sell its stake in Hulu, as well as the $2.2 billion sale of its Hudson Yards space. AT&T expects to end 2019 with a leverage ratio of 2.5x, which will further enhance the sustainability of the dividend.
AT&T has increased its dividend each year for over 30 consecutive years, and the stock has a high yield of 6.3% today. This makes AT&T the highest-yielding Dividend Aristocrat. Considering the S&P 500 Index, on average, yields just ~2% right now, AT&T is a highly attractive stock for income investors such as retirees, with a bit of dividend growth each year as an added bonus. AT&T stock trades for a price-to-earnings ratio of 9.1, which is below our fair value estimate of 12. Through valuation changes (+5.7%), dividends (+6.3%) and future EPS growth (+3.1%) we expect total returns above 15% per year over the next five years for AT&T stock.
2. Caterpillar Inc. (CAT)
Industrial giant Caterpillar is a recent addition to the S&P Dividend Aristocrats, having joined the list in 2019. It is particularly impressive for Caterpillar to be on the list, considering it operates in a highly cyclical industry. Caterpillar manufactures heavy machinery, meaning it is closely tied to multiple industries such as construction and mining. Caterpillar’s customers tend to report high growth during economic expansion, but struggle during recessions.
Caterpillar reported strong first-quarter earnings results. Quarterly sales increased 5%, while adjusted EPS increased 19%. Resource Industries reported segment sales growth of 18% to lead the way, thanks primarily to higher equipment demand and higher prices for its equipment. Caterpillar expects 2019 to be another strong year. At the midpoint of guidance, the company expects EPS growth of approximately 12% for 2019.
Caterpillar appears to be firing on all cylinders. The U.S. economy continues to grow at a steady pace, while commodity prices remain supportive of growth. This all bodes well for Caterpillar’s future earnings growth. Services are a separate growth catalyst for Caterpillar in the years ahead. Caterpillar expects to double its Machine, Energy & Transportation services sales to $28 billion by 2026, from $14 billion in 2016.
We expect Caterpillar to earn $12.25 per share in 2019. Based on this, the stock has a price-to-earnings ratio of 11. Our fair value estimate is a price-to-earnings ratio of 15-16, slightly below the 10-year average valuation multiple of 16.7. Expansion to this level would boost annual returns by 7.1% per year over the next five years. In addition, shareholder returns will be driven by earnings growth (6%) and dividends (3.1%). Overall, we expect total annual returns above 16% per year over the next five years for Caterpillar stock.
3. Walgreens Boots Alliance (WBA)
Walgreens Boots Alliance has increased its dividend each year for 43 consecutive years. It is a large pharmacy retailer with over 18,500 stores in 11 countries around the world. It also operates one of the largest global pharmaceutical wholesale and distribution networks in the world, with more than 390 centers that deliver to nearly 230,000 pharmacies, doctors, health centers and hospitals each year.
Walgreens is in a transition period. In response to the rise of e-commerce, Walgreens has had to invest in new growth initiatives. Brick-and-mortar retailers such as Walgreens are under immense pressure from Internet-based retailers. Fears of Amazon.com (AMZN) entering the health care industry are a constant challenge for Walgreens. Fortunately, Walgreens continue to grow revenue, thanks largely to its strong pharmacy unit.
In the most recent quarter, Walgreens’ revenue of $34.5 billion increased 5% year-over-year, as retail pharmacy sales increased 7.3%. Adjusted earnings-per-share (EPS) declined 5%, as the company dedicates additional resources to investing for the future. Walgreens is also working through reimbursement pressure, and lower generic deflation.
Walgreens is still highly profitable, with more than enough cash flow to invest for the future and pay a compelling dividend to shareholders. The company now expects adjusted EPS to be roughly flat in 2019, but we still forecast 6% annual earnings growth for Walgreens as it retains multiple competitive advantages, including its leading brand and global presence. In the meantime, investors can purchase Walgreens stock at a measurable discount to fair value.
Based on expected EPS of $6.02 in fiscal 2019. The stock has a price-to-earnings ratio of 8.6, well below our fair value estimate of 13.0. We view Walgreens as significantly undervalued. Expansion of the price-to-earnings ratio to 13.0 over five years could add 8.6% to Walgreens’ annual returns. In addition, we expect Walgreens to grow earnings by 6% per year, and the stock has a 3.4% dividend yield. Overall, Walgreens stock has expected returns of 18% per year over the next five years.
Relevant Articles:
- 2019 Dividend Champions List
- Dividend Aristocrats for 2019 Revealed
- Investing is part art, part science
- Twenty-Four Attractively Valued Dividend Champions for Further Research