Mr. Wonderful looks for stocks that exhibit three main characteristics. First, they must be quality companies with strong financial performance and solid balance sheets.
Second, he believes a portfolio should be diversified across different market sectors.
Third, and perhaps most important, he demands income—he insists the stocks he invests in pay dividends to shareholders.
The O’Shares FTSE U.S. Quality Dividend ETF (OUSA) owns stocks that display a mix of all three qualities. It is an interesting source of quality dividend growth stocks.
No. 10: PepsiCo (PEP)
Dividend Yield: 2.9%
Pepsi is one of the largest publicly traded food and beverage companies. The revenue mix is about 54% food to 46% beverage. It top brands include Pepsi, Frito-Lay chips, Mountain Dew, Tropicana orange juice, Gatorade , Doritos, and Quaker foods.
In Pepsi’s most recent quarter, revenue increased by 2.6% to $12.9 billion while diluted earnings per share grew 6.4% to $1.00 per share.
Pepsi is trading at 23.1x expected 2019 earnings. The company appears to be pricey relative to its historical average valuation levels. In the past decade, Pepsi’s average annual price-to-earnings ratio was 18.9.
Although Pepsi is more expensive than the S&P 500 right now, the company offers a dividend yield of 2.9%, which is more favorable than the overall market’s yield of ~1.8%.
In addition, PepsiCo has a highly secure dividend. PepsiCo is a Dividend Aristocrat, an exclusive group of S&P 500 Index companies with 25+ consecutive years of dividend increases.
Earnings per share are expected to grow about 5.5% per year over the next 5 years. Earnings growth will be comprised mainly of organic revenue growth, plus share repurchases.
This growth combined with the company’s 2.9% dividend yield gives investors expected total returns of 8% to 9% per year only if the company is able to maintain the high price-to-earnings ratio of about 23. it’s in investors best interest to wait for a pullback before buying at current prices.
No. 9: Philip Morris International PM +0% (PM)
Dividend Yield: 5.4%
Philip Morris sells cigarettes under the Marlboro brand and others, in international markets.
Philip Morris has been negatively impacted by a strong U.S. dollar. In the most recent quarter, its revenue declined by 2.1% to $6.8 billion compared to the same quarter in the prior year. Were it not for a strong U.S. dollar against other relevant currencies, revenue would have grown 3.2%.
Adjusted earnings per share were $1.09 against $1.00 in the same quarter of 2018. The company’s total international market share climbed 1.0 percentage points to 28.4%, while its total international heated tobacco unit market share rose 0.5 percentage points to 2.0%.
Although shipment volumes were roughly flat for cigarettes, heated tobacco units experienced double-digit growth by climbing 20.2% year-over-year. Still, heated tobacco units are a small part of the business — only making up roughly 6.5% of the shipment volumes for the quarter.
Philip Morris currently offers a juicy dividend yield of 5.4% compared to the S&P 500’s yield of ~1.8%. And, the company expects adjusted EPS to increase again in 2019, which will further boost the sustainability of the dividend. Management guidance calls for approximately 8% adjusted EPS growth for the full year 2019.
Philip Morris trades at 16.6x expected 2019 earnings. The company appears to be fairly valued relative to its historical average valuation levels. In the past decade, Philip Morris’ average annual price-to-earnings ratio was 16.5.
No. 8: Pfizer Inc. (PFE)
Dividend Yield: 3.7%
Pharmaceutical companies benefit from the fact that many people cannot go without their medications. This heavily insulates Big Pharma’s bottom line. Further, pharmaceutical companies have the ability to raise prices on key drugs. Because of this, healthcare stocks like Pfizer have proven to be stable dividend payers.
In 2018, Pfizer’s revenue increased by 2%, while its adjusted earnings-per-share rose 13% to $3.00. Pfizer has a strong oncology portfolio and has been spending a large portion of its investments in this area. Currently, it has 18 approved cancer medicines and biosimilars and up to 20 potential approvals expected by 2025. Down the road, new drugs should help boost Pfizer’s revenue.
The drug manufacturer has historically generated pretty stable earnings through economic cycles. Coupled with a sustainable payout ratio of about 50% this year, investors can continue to expect steady dividend growth that more or less matches with earnings growth. With this in mind, it’s unsurprising that Mr. Wonderful has Pfizer as a top 10 holding.
Pfizer trades at 13.7x expected 2019 earnings. The company appears to be fairly valued. The stock offers a dividend yield of 3.7. Earnings-per-share growth is estimated to be about 5% per year over the next few years. So, an investment today can deliver total returns of roughly 9% per year.
No. 7: Chevron (CVX)
Dividend Yield: 4%
Chevron has a $223 billion market cap, making it one of the largest oil and gas companies. And, it has paid an increasing dividend every year since 1988 which makes Chevron a Dividend Aristocrat .
Despite the oil and gas price collapse in 2014 that left energy companies with a much more challenging environment to operate in, Chevron still managed to increase its dividend at a compound annual growth rate of 2.8% in the last five years. At the start of 2019, Chevron increased its dividend per share by 6.25%, which suggests the operating environment has improved.
Chevron aims to sell $5-10 billion of assets from 2018-2020 to improve its upstream portfolio. Chevron now enjoys an industry-leading balance sheet and the lowest cash flow breakeven oil price among its competitors, including BP (BP), Royal Dutch Shell (RDS.A)(RDS.B), Total (TOT), and Exxon Mobil (XOM).
Although Chevron enjoys the lowest cash flow breakeven oil price among the Big Oil Majors, it doesn’t change the fact that it will be a major beneficiary if commodity prices continue to rise moving forward. Additionally, Chevron stock currently offers an attractive 4% dividend yield.
No. 6: Home Depot HD +0% (HD)
Dividend Yield: 2.7%
Home Depot is the largest home improvement retailer in the United States with a market capitalization of almost $225 billion.
It’s not hard to see why Mr. Wonderful is a fan of Home Depot. The company has long been a leading operator in its industry and passes its financial success onto its shareholders in the form of steadily rising dividend payments.
Most recently, in February 2019, Home Depot increased its dividend by 32%, equating to an annual payout of $5.44 per share. Its payout ratio is about 55%, indicating there is room to grow the dividend in the future.
Fiscal 2018 was another successful year for Home Depot. The home improvement retailer saw sales increase by 7.2% to $108 billion, net earnings increase by 29% to $11.1 billion, and diluted earnings-per-share increase by 33% (partly boosted by share repurchases) to $9.73.
We think Home Depot will handsomely reward long-term investors who buy the dividend growth stock on meaningful dips.
No. 5: Intel INTC +0% Corp. (INTC)
Dividend Yield: 2.5%
The technology sector is a surprisingly good source of dividend stocks such as Intel. The company has a market-beating 2.5% dividend yield and is well positioned to benefit from trends such as autonomous driving and the Internet of Things.
More broadly, Intel’s products (microchips and semiconductors) will experience increasingly strong demand as the demand for data undoubtedly continues to grow at a torrential rate.
Intel has three major focuses that it calls ‘big bets’ and is devoting significant resources to developing.
The first is memory. As an existing leader in this market, Intel is likely to benefit from growth in this fast-growing segment of the technology industry.
The second is autonomous vehicles, which the company expects to be mainstream by 2030 thanks to companies like Tesla (TSLA), General Motors (GM), and Ford (F).
The third is 5G, which is expected to connect 50 billion devices once implemented.
Intel’s market leadership and robust dividend supported by a payout ratio of about 30% certainly seem like quality to us, and definitely contribute to the company being held in Mr. Wonderful’s investment portfolio.
No. 4: Procter & Gamble (PG)
Dividend Yield: 2.8%
Procter & Gamble has increased its dividend for the past 60 years in a row. This makes the company one of only 24 Dividend Kings; stocks with 50+ years of rising dividends.
From fiscal 2014 to 2017, net sales fell 12.5% and adjusted-earnings-per-share fell 7.1% as P&G offloaded about 100 non-core brands. This has allowed P&G to streamline its operations and focus on the remaining 65 core brands, which management believes hold the most growth potential.
The strategy to spur growth has started to bear fruit. In fact, adjusted earnings-per-share bottomed in fiscal 2016. Since then, adjusted earnings-per-share has climbed 7-8% per year.
P&G applied more agile innovation principles and was able to bring Pampers Pure diapers to consumers in about half the time of a typical rollout in the capital-intensive diaper market.
Cost cutting and focusing on core brands helped boost profitability and growth. Earnings growth has led to improving dividend growth. In fiscal 2017, 2018, and 2019, P&G increased its dividend per share by 1.5%, 3.3%, and 4%, respectively. P&G has a highly secure dividend payout.
The stock’s yield of 2.8% is a big boost from the market’s 1.8%. However, total returns will likely be below average because the stock appears overvalued at the moment.
No. 3: Exxon Mobil (XOM)
Dividend Yield: 4.5%
Exxon Mobil is the largest publicly traded oil company in the world. It has a $329 billion market cap and joins Chevron as the only energy sector Dividend Aristocrats thanks to its 36 years of consecutive dividend increases.
Despite the oil and gas price collapse in 2014 that left energy companies with a much more challenging environment to operate in, Exxon Mobil still increased its dividend at a compound annual growth rate of 5.6% in the last five years — this was double the dividend growth rate of Chevron.
At the start of 2019, Exxon Mobil increased its dividend per share by 6%, which is in line with its five-year dividend growth rate of 6%. The oil giant’s consistent dividend growth is thanks to an integrated business model with upstream and downstream operations and a competent management team that continues to optimize the business that spans the full value chain.
Maintaining profitability is crucial for a company in order to continue raising its dividend. Exxon Mobil has been doing a good job in that respect, and it will be a major beneficiary if commodity prices rise. Exxon Mobil stock has an attractive 4.5% dividend yield.
No. 2: Johnson & Johnson (JNJ)
Dividend Yield: 2.7%
J&J is one of the safest dividend stocks investors can buy, so it is not surprising to see it in Mr. Wonderful’s portfolio. This year marks the company’s 57th consecutive year of dividend growth, an incredible dividend history which makes J&J a member of the Dividend Kings.
J&J’s long history of dividend growth is thanks to its excellent business model. J&J has a very strong brand—approximately 70% of the company’s sales come from products that have either the number one or number two positions in their respective categories.
This brand strength has led to consistent growth for decades. According to J&J, it has achieved positive growth in adjusted earnings per share for 35 consecutive years. J&J is organized into three business segments:
- Pharmaceutical (40.7% of sales)
- Medical Devices (27% of sales)
- Consumer (13.9% of sales)
The pharmaceutical business is performing the best so far this year, with 4.1% revenue growth to $10.2 billion through the first quarter. However, sales of the consumer and medical devices segments declined 2.4% and 4.6%, respectively, to $3.3 billion and $6.5 billion. For 2019, management estimates total revenue to stay more or less flat and earnings-per-share growth to be roughly 5%. It is likely the diversified healthcare giant will continue its steady growth for decades to come.
J&J it is not particularly pricey compared to other stocks in the S&P 500. A rising tide lifts all valuations – and J&J is no exception. J&J makes a great core long-term holding for risk-averse dividend-growth investors.
No. 1: Cisco Systems CSCO +0% (CSCO)
Dividend Yield: 2.5%
Cisco is a global technology leader. The strong run-up of more than 60% in the stock over the last two years or so has made Cisco the largest holding in Mr. Wonderful’s portfolio.
The tech company is a relatively young dividend-growth stock. Cisco only started paying a dividend in 2011, but proceeded with a dividend hike every year since. Incredibly, its dividend is 11x what it was eight years ago.
With a payout ratio of about 46% this year, Cisco will likely continue growing its dividend closer to its earnings growth rate moving forward. Cisco brings in annual revenues of about $49 billion and enjoys high margins. Its five-year operating margin is north of 24%.
Cisco stock has a forward price-to-earnings ratio of 18.3. This is higher than its decade’s average of about 15. The company has experienced multiples expansions due to having an increasing subscription-based revenue that leads to higher predictability. The stock does look moderately overvalued today based on our estimated earnings-per-share growth rate of about 6% over the next few years. Interested investors should look for a better entry point.