Successful dividend investing involves more than just picking high yield stocks. This is because struggling businesses often carry temporarily high dividend yields, making it difficult to distinguish between good and bad companies.
A company’s dividend growth is just as important as its dividend yield, as a stock with consistent dividend growth often delivers superior dividend income and capital growth over the long term.
With this in mind, here are 3 top dividend growth stocks:
Passive income stocks: our picks
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Wide Economic Moat
Unilever’s (LSE: ULVR) shares, which trade at 21.4 times its expected 2016 earnings and yield just 2.9%, may seem unattractive at first glance. But, when we consider peer valuations, the company’s growth prospects and its wide economic moat, we may come to a different conclusion.
The company’s economic moat is not just wide, it also appears to be expanding. This is best demonstrated by its improving operating margins. In 2015, Unilever’s core operating margins rose 30 basis points, to 14.8%. Looking forward, I believe the company’s expansion into the personal care market, particularly at the premium end, would lead to a further widening in margins. The fragmented structure of the personal care market means Unilever has the opportunity to make additional acquisitions there, and further consolidation should boost profitability.
Moreover, Unilever is not the most expensive stock in its peer group. Reckitt Benckiser and Associated British Foods, two of its large-cap peers, are considerably more expensive, trading at 24.3 and 33.0 times their respective 2016 forecast earnings.
Non-cyclical appeal
As tobacco consumption is generally independent of cyclical trends, tobacco stocks may become particularly appealing as concerns over the slowing global economy grow. British American Tobacco (LSE: BATS) is the UK’s largest listed tobacco company, with annual sales in excess of £13 billion.
The stock fetches 17.2 times its estimated 2016 profits, which doesn’t look cheap. However, it does carry a 3.9% dividend yield. What’s more, British American Tobacco is expected to increase dividends per share by almost 7% this year, which puts its prospective dividend yield at 4.2%.
With dividend cover at 1.4x, reasonable leverage and interest cover in excess of 10 times, I would expect more dividend growth is still to come.
Steady Growth
Leading outsourcing company Capita (LSE: CPI) has a great track record of delivering recurring earnings growth and value to shareholders. Over the past five years, underlying earnings and dividends per share have increased by a compound annual growth rate (CAGR) of 10%.
Earnings growth is now slowing, but it remains at a very respectable pace by any standard – around 9% in its latest reported figures. Underlying operating margins, which had been steadily falling since 2011, made a recovery in 2015 of 50 basis points, to 13.7%. This was primarily due to the exiting from some of its non-core assets, but also because of a widening of operating margin on a like-for-like basis.
City analysts expect underlying EPS will rise 7% this year, which would value Capita at a very reasonable 13.5 multiple on its expected earnings. For the following year, forecasts point towards a further 6% growth in adjusted EPS, lowering its 2017 forward P/E to just 13.0.
Its shares currently yield 3.2% and analysts expect this will rise to 3.4% this year.
