Oftentimes a stock has a high yield simply because it has recently underperformed the stock market. But many of the best dividend stocks combine dividend raises with capital gains, giving investors a source of passive income and access to the risks and potential rewards of the stock market.
Microsoft (MSFT -1.73%), Emerson Electric (EMR -0.54%), and Hubbell (HUBB -1.71%) are three dividend stocks that don't sport the highest yields. But Microsoft and Hubbell have trounced the S&P 500's performance over the last five years, while Emerson blends an ultra-reliable yield with slow and steady growth.
Here's why all three stocks are worth buying now.
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Microsoft remains very committed to its dividend
Daniel Foelber (Microsoft): Today folks think of Microsoft as a tech giant with massive growth potential, not a dividend stock. After all, Microsoft yields just 0.8%. But Microsoft's low yield is the result of its outperforming stock price, not a lack of commitment to dividend raises.
In fact, Microsoft has raised its dividend for 20 consecutive years. In Q1 of fiscal 2024, its most recent quarter, it paid a $0.75 per share dividend. The distribution marked an all-time high quarterly dividend and an over-10% increase from its prior dividend.
Five years ago Microsoft was trading around $100 a share. If the stock had gone nowhere, the company's forward yield would have been 3% today, not 0.8%. Microsoft provides a good lesson that a low yield isn't indicative of a bad dividend stock, and is sometimes just due to a strong performance. Investors would surely trade a near four-fold increase in their Microsoft investment in five years for a lower yield.
Microsoft is up a staggering 57.5% year to date. The gain has far outpaced the company's earnings growth. As a result, Microsoft's price to earnings (P/E) ratio has ballooned to 36.6 -- well above its five-year median P/E ratio of 31.4. This is a sign that the market is pricing in higher future growth and is willing to pay a higher price for the stock today, even if its current earnings have yet to reflect that growth.
Microsoft isn't cheap. But the company is nothing short of a cash cow. It has more cash on its balance sheet than debt, and has a business model capable of supporting dividend raises no matter the market cycle. What makes Microsoft a unique investment is that the stock has tons of upside potential from its legacy businesses, its growing cloud business, and artificial intelligence (among other things). But even if the stock stalls, investors can count on sizable dividend raises.
There aren't too many companies out there with the financial muscle and market positioning of Microsoft that have plenty of cash flow to fund buybacks, dividend raises, and expensive research and development budgets, and still have plenty of money left over. Add it all up, and Microsoft is an excellent choice for risk-tolerant investors looking for a company's commitment to its dividend rather than a high yield today.
Emerson Electric can charge your passive income stream
Scott Levine (Emerson Electric): Raising its payout for 66 consecutive years, Emerson Electric is a Dividend King that's as steady as they come. It's no small feat for a company to achieve a record such as this, and it doesn't seem like Emerson Electric, a leading provider of electrical solutions, will fail to extend its streak in 2024. For those looking to fortify their portfolios with a tried-and-true income stock, Emerson Electric -- along with its 2.4% forward-yielding dividend -- is a worthy consideration.
While companies will placate shareholders with hefty payouts, jeopardizing their financial wellbeing in the process, Emerson Electric takes a more judicious approach. Over the past 10 years, Emerson Electric has averaged a conservative payout ratio of 57.8%. The company's strong free cash flow provides further evidence that the dividend is not imperiling its financial health. From 2020 through 2022, Emerson Electric generated annual average free cash flow of $2.6 billion, and it returned $1.2 billion on average to shareholders in the form of dividends.
A strong backlog further buttresses the bull case for Emerson Electric. The company recently reported that its backlog stands at $6.6 billion at the end of fiscal 2023, having climbed 12% year-over-year -- and that's not including any backlog associated with AspenTech, which Emerson Electric acquired in 2022. AspenTech occupies a valuable place in Emerson Electric's portfolio. In 2023, for example, Emerson Electric reported earnings per share of $3.72, of which AspenTech contributed $0.27, and AspenTech contributed $305 million in free cash flow.
A rising dividend signals management's confidence in its growth outlook
Lee Samaha (Hubbell): Electrification and utility solutions company Hubbell recently raised its dividend to a record $1.22 a quarter. While the current yield of 1.62% isn't anything to write home about, the 9% increase in the dividend payout is an indication of the underlying strength of the business.
In a nutshell, Hubbell is a play on the electrification of the economy. It's a compelling trend driven by the ongoing need to replace and upgrade existing transmission and distribution networks. At the same time, the growth of renewable energy, electric vehicles, the Internet of Things, and other technologies that require electricity to function is adding new sources of demand.
These solutions are known as being in "front of the meter" and are sold through its utility solutions segment, responsible for 58% of sales in 2022. They also include smart meters and control devices that manage how energy and data are transferred between utilities and operators -- likely to be a growing market given advancements in smart technology.
The other segment, electrical solutions (accounting for 42% of sales in 2022), has "behind the meter" solutions that help operators and industrial customers operate their energy infrastructure efficiently.
The positive momentum in its business can be seen in the increase in management's expectations for organic sales growth of 7% in 2023 from an initial estimate of 4%-6%. Management said its transmission end market has robust in the third quarter, and is seeing strength in renewables and data centers that more than offsets softness in telecom and consumer markets. Wall Street analysts are expecting another year of high-single-digit revenue growth in 2024, and given the strength in the electrification-of-everything megatrend, Hubbell could be set for growth for many years to come.
