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Dividend stocks can be the foundation of a great retirement portfolio. Not only do the payments put money in your pocket, which can help hedge against any dips in the stock market, but they're also usually a sign of a financially sound company. Dividends also give investors a painless opportunity to reinvest in a stock, thus compounding gains over time.
However, not all income stocks live up to their full potential. Using the payout ratio -- i.e., the percentage of profits a company returns to its shareholders as dividends -- we can get a good bead on whether a company has room to increase its dividend. Ideally, we like to see healthy payout ratios between 50% and 75%.
Here are three income stocks with payout ratios currently below 50% that could potentially double their dividends.
Anthem
We begin this week by looking at a veritable giant in the health insurance space, Anthem (ELV -0.61%), which is currently paying out $2.60 annually, good enough for a 1.9% yield.
Like most national insurers, Anthem's biggest challenge is keeping its medical costs down. This has been difficult since the adoption of the Affordable Care Act, also known as Obamacare, which has opened the floodgates for sicker and costlier people with pre-existing conditions to enroll. Prior to Obamacare, insurers could turn individuals with pre-existing conditions away. The result for Anthem and its peers has generally been higher costs and ACA-based disappointment.
Despite Obamacare woes, Anthem has a number of factors working in its favor that should result in stronger long-term profitability, and thus juicier dividend payments for shareholders.
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Front-and-center, the long-term data is working in Anthem's favor. America's population is growing and aging, which means a steady opportunity to grow its member base and to charge higher premium prices to cover the rising costs of medical treatment. Though Anthem's benefit expense ratio rose 210 basis points in the second quarter from the prior year to 84.2% (a lower number is better), the fact that it's bringing in more than enough in premiums to cover its expenses across all business segments is a testament to the discipline of its management team.
Inorganic growth opportunities are also a potential positive for Anthem. To name one example, Anthem has offered to buy rival CIGNA (CI) for $48 billion. Doing so would create a new largest insurer in the country, as well as help the two companies save a lot of money by eliminating overlapping programs. A combination would also make operating on Obamacare's marketplace exchanges substantially more affordable. For the time being, the Justice Department has moved to block the deal -- but even if it doesn't go through, there will presumably be M&A opportunities on a smaller scale available for Anthem to choose from to grow its business.
Anthem's focus on government-sponsored patients has also been a boon for the company. Medicaid-based patients may have lower margins than members not receiving subsidies, but a government-sponsored patient means a guaranteed payment in Anthem's pocket. Not to mention government-sponsored members are less likely to drop their coverage.
With Wall Street aggressively predicting nearly $16 in EPS by 2019 for Anthem, I'd suggest its current dividend payout could easily double within the next 5 to 10 years.
Best Buy
Yes, I'm really suggesting dividend investors take a closer look at big-box retailer Best Buy (BBY -2.50%), and no, I haven't been drinking. The retail giant is currently paying out $1.12 annually, which works out to a delectable 3.4% dividend yield. My suggestion is that this payout could double to $2.24, or higher, over the next decade.
The biggest issue Best Buy has been dealing with for the better part of a decade now is the rapid growth of online sales. In a process known as "showrooming," consumers would visit electronic big-box retailers like Best Buy to try out new products, only to purchase the products online through Amazon.com (AMZN -1.09%), eBay, or some other e-commerce retailer to save money. Best Buy was essentially losing based on convenience. But it's taken its lumps and learned its lessons, and now Best Buy appears stronger than ever.
Image source: Best Buy.
Best Buy's growth strategy has three key cogs that should lead to success. First and foremost, Best Buy is focused on growing its online sales. Estimates from eMarketer.com project that online sales of computer and consumer electronics will more than double between 2012 and 2018 from $49 billion to $108.4 billion, giving Best Buy a prime opportunity to grow its sales. During the first quarter, Best Buy announced a 23.9% increase in online sales to $832 million. As a percentage of domestic revenue, online sales now represents 10.6%, a 210 basis point improvement from the year-ago period. In other words, Best Buy is taking on Amazon and having success keeping some of its customers loyal to its brand.
Secondly, Best Buy is focused on stringent cost controls. The company has been closing underperforming big-box and mobile store locations in an effort to reduce its expenditures, while also being considerably more prudent about the type of discounting it offers. It's certainly hard to argue with the results, as the company's Q1 2017 report showed a 10 basis point increase in adjusted gross profit rates domestically, and a 310 basis point improvement internationally.
Lastly, Best Buy is having success utilizing the store-within-a-store concept. By renting out space within its stores to well-known brand names, like Apple and Samsung, Best Buy has found a new channel of revenue, and it's also created a more efficiently modeled store where turnover is higher and sales per square foot are increasing. The store-within-a-store concept has also seemingly increased foot traffic.
With Best Buy having a real shot at $4+ in annual EPS by 2020 or 2021, I'd suggest dividend increases could be on the way.
Synchrony Financial
Last, but not least, income investors looking for strong dividend growth would be wise to turn their attention to Synchrony Financial (SYF -1.24%), the consumer and business credit services company spun off by General Electric in 2014.
Synchrony's biggest obstacle is that Wall Street is still feeling out what to expect from this still freshly independent company. In June, Synchrony partially sounded the alarms when it announced that its anticipated net charge-offs would rise by 20 to 30 basis points to a range of 4.5%-4.8%, which is notably higher than those of most banks. The company blamed a tougher loan recovery environment for its reduced forecast.
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Despite this mild warning, Synchrony has specific business attributes that make it quite attractive for long-term investors seeking income growth.
The most attractive component to Synchrony Financial's business model is its private label credit cards, or PLCCs. The company provides credit services to retail giants likes Amazon.com and Wal-Mart that benefits both the retailer and consumer. PLCCs help keep consumers loyal by typically offering rewards or purchasing convenience, while for the retailer they can possibly help avoid the middleman fees charges by payment processing facilitators like Visa and MasterCard. PLCC usage should continue to march higher as long as the U.S. economy keeps chugging along.
Synchrony's CareCredit business could also surprise investors over the long run. This is a way for patients to get revolving access to credit and payments options for health-related treatments and procedures. With healthcare costs growing, consumers could be forced to turn to promotional credit offers to assist them in meeting their health-based financial obligations. Like Anthem above, the long-term population trends are working in favor of CareCredit.
Having recently announced a $0.13 per quarter payout, Synchrony is now yielding 1.9%. However, with only $0.52 being paid out annually per share, and the company on track for $3 in full-year EPS by 2017, a series of dividend increases resulting in a double (or more) from current levels seems likely.
