As I regularly scan Wall Street research, I sometimes come
across an eye-catching headline.
Merrill Lynch's recent report on agricultural equipment
Agco (Nasdaq: AGCO)
is a great example: "Margin Upside, Divy Could Soar, Raising
Estimates." It's the middle part that got my attention.
Merrill's analysts noted the dividend could be poised for a
big change: "AGCO currently pays out only 7% of earnings per
share (EPS) in the form of dividends. The dividend could triple
in the next few years on flat EPS of $6 if the company simply
goes to a 20% payout ratio."
What those analysts didn't say: Many companies pay out 40% or
more of their income to dividends, which means the dividend
payments could actually swell far higher than these analysts
The Revolution Is Already Underway
Have the executives at Agco been under a rock these past few
years as other companies have already sharply hiked their
payouts? No, they just wanted to show an extra dose of patience
before making such a big move. After all, it feels as if we're
not far removed from many recent global crises.
Yet Agco, like many other firms, now sees that the U.S. and
Europe, which still account for half of global GDP, are proving
to have increasingly resilient economies. And you can see the
confidence in the form of improving financial projections: In its
view of Agco, for example, Merrill Lynch foresees "further
opportunity for margin expansion in coming years based on the
company's numerous internal initiatives," predicting free cash
flow will rise nearly 150%, to $570 million, by 2015.
Not Yet On The Radar
As Agco's dividend currently yields just 0.6%, most
income-focused investors still haven't looked at this company. A
tripling of the dividend would simply push the yield into
respectable (but not great) territory. But what about companies
that have decent yields now, but are poised for great yields in
the years to come?
I went in search of stocks that currently yield more than 1%,
but could be yielding 3%, 4% or even 5% in a few years. To find
them, I focused on companies with very low payout ratios. Of all
the companies in the S&P 500, 400 (mid-cap) and 600 (small
cap), these are the companies with the lowest payout ratios with
a current dividend yield of at least 1%.
In line with Merrill Lynch's logic regarding Agco, these
companies could triple their payout ratio, pushing up their
dividend yields above 4% in some instances.
Of course, investors may want to seek out companies that
already offer more appealing yields but are in a position to
boost their dividends at a still-strong pace. Looking at that
same group of 1,500 companies, here are the highest current
yielders that have a payout ratio below 30%.
You'll notice that women's apparel retailer
Cato Corp. (Nasdaq: CATO)
makes both lists. The company is what we here at StreetAuthority
call a "
" Go to any popular financial website, and it will appear as if
Cato pays annual dividend of a paltry $0.20 a share. But looks
are deceiving. Cato likes to maintain a conservative formal
dividend, but often manages to slip in irregular dividend
payments that can start to really add up.
Cato's Hidden High Yield
In its most recent fiscal year, Cato delivered an extra
$1-a-share dividend ahead of looming changes in the tax code, so
don't look for a similar payout this year. But if history is any
guide, future annual dividends will be a lot closer to $1 a
share, and not just the $0.20 a share that many websites will
Dow Chemical (
is another example of a company positioned for robust dividend
growth, thanks to an ongoing balance sheet transformation. The
chemical giant had been carrying an ungainly balance sheet, as
long-term total debt rose to $20.6 billion by the end of
Yet Dow now appears committed to shrinking that debt load:
It's already less than $17.5 billion and should sink below $15
billion over the next two years, according to management. As debt
moves to more manageable levels, look for Dow to shift its focus
toward dividends. The payout has already been boosted from $0.60
a share in 2010 to a current $1.28 a share (good for a 3.3%
But the smaller debt load should enable Dow Chemical to double
its payout ratio in coming years, setting the stage for a
dividend yield above 6% (if you lock in at today's stock
Risks to Consider:
We're in the midst of a steady expansion in payout ratios,
but companies tend to reduce their dividends when the economy
contracts, as was the case in 2008. So keep an eye on the broader
economic environment in which each of these companies
Action to Take -->
Certain industries predominate the "low payout ratio" theme.
Banks and insurers, many of which are only now sufficiently
capitalized to satisfy regulators, stand to pay solid attention
to their dividends in coming years. Insurers
Protective Life (
, for example, all have payout ratios below 20% (and typically
trade below book value as an added value kicker).
If you're in search of stocks that can offer robust dividend
growth, simply calculate how much of their current earnings are
geared toward the dividend. If the payout ratios are below 20%,
and cash flow appears to be stable and growing, then you may be
looking at some of the dividend stars of 2014.