This is a guest contribution from Bob Ciura of Sure Dividend.
Income investors have long sought out the stocks with the best long-term prospects for rising income. The idea is simple: find the companies with the highest likelihood of being able to perform well in any economic climate, affording those companies the ability to rising dividends.
There are 65 such companies on the list of Dividend Aristocrats, a group of S&P 500 stocks that have at least 25 consecutive years of dividend increases. These companies have stood the test of time when it comes to earnings and dividends to shareholders, and below, we’ve selected three we believe are top buys today.
AT&T (T)
AT&T is a telecommunications giant that traces its history back to the late-1880s. The current company is the result of several large mergers and today, AT&T trades for a $190 billion market capitalization, and generates about $170 billion in annual revenue.
AT&T has built a highly diversified telecommunications business over time with acquisitions such as DirecTV and Time Warner, moves which were outside of its core areas of competency. AT&T still derives much of its revenue and profit from its core Communications segment, which provides wireless, broadband, and video services to ~100 million US consumers, a business which is stable over time. This allows AT&T to invest in growth via acquisition, which it has made full use of in recent years.
We believe AT&T’s model will continue to work in variety of economic climates because it is highly entrenched among consumers, where switching costs tend to be high. AT&T is the sole provider of broadband and video services in certain areas, and switching wireless providers is costly for consumers in many cases. This leads to very low rates of churn, so AT&T should be able to weather whatever storm comes its way.
AT&T’s yield is enormous currently because of a huge selloff in the stock this year. However, despite this massive yield, AT&T’s dividend still appears safe. The payout ratio for 2020 is currently forecast to be just 64%, meaning there is significant room for continued increases in the years to come.
With stable earnings, the opportunity for modest growth, and a relatively low payout ratio, AT&T should be able to continue to grow its dividend for many years to come. We see payout growth as somewhat muted given the already-high yield and AT&T’s desire to deleverage, but over time, AT&T should remain a dividend growth stock.
Chevron Corporation (CVX)
The next stock in our list is energy behemoth Chevron Corporation. Chevron traces its lineage back to Standard Oil, before it was broken up in the famous antitrust action from more than a century ago. Today, the company is one of the largest oil companies in the world based on its current market capitalization of $136 billion. Chevron, like AT&T, has had a tough 2020, but should still produce more than $100 billion in revenue this year.
We see Chevron’s model as sustainable in the long-term because it has enormous scale in supplying current energy needs globally, as well as an eye toward the future. In other words, Chevron continues to produce vast quantities of oil and natural gas products, as those are highly profitable today. It also has a sizable chemicals business that helps diversify revenue away from direct energy usage for gasoline, heating, etc.
Chevron is also investing in clean energy technology that will, hopefully, one day power the company’s revenue and profits as the use of fossil fuels declines over time. Chevron is keenly aware of this issue, but has the willingness and cash to do something about it before it is too late. Given all of this, we believe Chevron’s model can succeed for many years to come.
Massive swings in oil prices have caused Chevron’s earnings to be quite volatile over time, thereby driving the payout ratio quite high. This year is a good example of that as earnings are expected to plummet on extremely weak demand due to COVID-19. With negative earnings expected, Chevron’s payout ratio isn’t meaningful. However, the company has proven it has the cash flow to continue to pay the dividend during very tough times, as it has for more than three decades. Thus, while Chevron’s payout ratio may not inspire confidence, we see the opportunity for long-term dividend growth as earnings and cash flow normalize.
Walgreens Boots Alliance (WBA)
Our final stock is Walgreens Boots Alliance, the largest retail pharmacy in the US and in Europe. The company operates in 25 countries around the world and has in excess of 400,000 employees, making it one of the largest companies in the world by that measure.
Walgreens operates nearly 19,000 stores globally, which have front-end retail operations as well as lucrative pharmacies within. Walgreens should produce about $143 billion in revenue this year, and it has a market capitalization of $32 billion.
Walgreens should be able to produce strong earnings for the foreseeable future because of its leverage to the pharmacy business, which has experienced enormous growth in recent years. Healthcare costs continue to rise, including prescriptions, and volumes for Walgreens have risen over time as well, creating a virtuous upward revenue cycle. The retail business has been much weaker, and we don’t expect that to necessarily contribute to earnings performance over time. However, Walgreens has proven its model can work in a variety of conditions, which is exactly what investors need for long-term dividend growth.
Walgreens’ dividend payout ratio is just 40% for this year, meaning there is a very long runway for not only dividend safety, but growth as well. Walgreens easily has the most sustainable payout of the three stocks in this list, and has the most opportunity to grow the payout of the three. Thus, we see Walgreens as a very strong dividend growth stock for the years to come, extending Walgreens’ already-impressive 45-year dividend increase streak.
Final Thoughts
These three stocks all have business models we find to be quite resilient, which should afford them the ability to not only maintain, but grow their payouts over time. Chevron and AT&T both have 7%+ current yields after nasty selloffs for each stock in 2020, and Walgreens has the safest payout, while also having the most room to growth the dividend over time. However, all three offer dividend and income-focused investors the chance to buy and hold for rising income over time.