Instead of chasing dividend stocks with precariously high yields, look for strong income-producing stocks that have a consistent history of raising their dividend yet have modest yields and low payout ratios.
In some cases, companies with really high yields on their dividend got that way because their share price plummeted, and that could mean a dividend cut may be on the way, further eroding a stock's price.
As the cliché goes, past performance doesn't guarantee future results. Look no further than Royal Dutch Shell and Ross Stores; they were Dividend Aristocrats, companies that had raised their dividends for 25 or more years, until they cut and suspended, respectively, their dividends last year.
What you need to look for are companies who have already doubled their dividends in recent years, yet still have low payout ratios — such as Lowe's (NYSE: LOW), American Express (NYSE: AXP), and Sherwin-Williams (NYSE: SHW).
Build your dividend portfolio with Lowe's
Lowe's is a Dividend Aristocrat that has been raising its quarterly dividend for more than 25 years, including a 33% jump this year to $0.80 per share. It only took four years for the company to double its $0.39 per share quarterly dividend in 2017 to its current payout. The way business has been going for the home improvement company, I can see the dividend doubling in less time this time around.
Let's start with the dividend's safety. The company has seen profits soar, so the dividend's yield isn't that high — around 1.3% at Friday's closing share price. The company's cash dividend payout ratio, trailing 12 months (TTM) is only 19%, well below the consumer products sector average. That means the company can easily afford to continue raising its dividend.
Lowe's, with a share price that has risen more than 20% so far this year, continues to see tailwinds that began with people fixing up their homes during the pandemic. In the first quarter, the company reported sales of $24.4 billion, up 24.1% year over year, while earnings per share were $3.21, up 81% compared to the same period in 2020. It also increased gross margins slightly.
American Express is a dividend you can bank on
American Express, hampered by the pandemic last year, has kept its quarterly dividend to $0.43 per share, offering a yield of 1% at Tuesday's share price. I see no reason why it won't soon go up because the company is coming off a strong quarter as the economy opens up and, particularly important for American Express, people begin to travel again. The company's dividend doubled from 2013 to 2016, and looking at the company's financials, it could happen again within a few years.
While it hasn't regularly raised its dividend as much as some other companies, it hasn't cut its dividend in 27 years.
In the second quarter, which the company just announced on Friday, it reported revenue of $10.2 billion, up 33% year over year. Net income was $2.3 billion ($2.80 a share) compared to $257 million ($0.29 a share) in the same period in 2020.
So far this year, the company's stock is up more than 43% and its cash dividend payout ratio is a very conservative 17%, leaving plenty of room for growth. A key for the company has been its increased marketing toward younger consumers such as millennials and Generation Z, who are expected to increase spending as they age. The company said in the last quarter that it added 2.4 million new card holders, with the greatest increase in spending among millennials, Gen-Z, and small business owners.
Sherwin-Williams' dividend is well covered
Sherwin-Williams already doubled its dividend from 2015 to 2020 and it's on pace to do it again, perhaps this time in less than five years. The company raised its quarterly dividend 23% to $1.65 per share this year (though it is now $0.55 per share after a three-for-one stock split in April), the 43rd consecutive year the paint and coatings company has increased its dividend.
Sherwin-Williams has a strong market share, particularly since its purchase of Valspar in 2017, and that gives it strong cash flow. It is the largest paint and coatings company in North America, according to the annual report by PCI Magazine. Sherwin-Williams continues to be conservative with a cash dividend payout ratio of 16%, so there's no reason to see it needing to cut its dividend.
So far this year, the company's stock has risen more than 17%. The company just issued second-quarter earnings on July 27. Net sales were reported at $5.38 billion, up 16.9% year over year. Net income per share, diluted, was $2.65, up from $2.37 in the same period last year. In June, the company increased its full-year sales guidance to show a high-single-digit to double-digit gain over 2020. It also said it expected full-year earnings per share of $8.01 to $8.31, up from $7.36 a share in 2020.
Like Lowe's, the company has benefited from the trend of homeowners fixing up their homes during the pandemic, but now the company said it is starting to see growth on the industrial side as well.
All three could double their dividend
All three of these income-producing stocks have tailwinds that should allow them to grow revenue, and dividends, for the next few years. While the home improvement trend may slow slightly, it's not likely to go away completely, so that should help Lowe's and Sherwin-Williams, particularly as they will benefit this year as businesses increase purchases. American Express will be helped by the increased spending power of younger generations, so that's another long-term trend.
Of the three, I like Sherwin-Williams the most because it has the longest tradition of increasing its dividend and is in a dominant position in the market, allowing it to have more control over pricing. Lowe's and American Express are also strong picks as well, but to me, Lowe's has a slightly better yield and a more consistent history of dividend raises which gives it the nod over American Express.
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American Express is an advertising partner of The Ascent, a Motley Fool company. Jim Halley has no position in any of the stocks mentioned. The Motley Fool recommends Lowes and Sherwin-Williams. The Motley Fool has a disclosure policy.