Some companies offer the option of automatic Dividend Reinvestment Plans DRIPs to their shareholders. In other words, their shareholders can choose to receive their dividends in shares instead of cash. These plans have significant advantages, as they are usually free of commissions and help investors maximize the benefit from compounding their income streams.
In addition, it prevents investors from making emotional mistakes, such as avoiding to purchase shares during bear markets, when the market sentiment is negative.
Let's discuss the prospects of three dividend growth stocks that offer DRIP plans.
This 'King' Provides the Tools You Need
Illinois Tool Works (ITW) is a diversified multi-industrial manufacturer with seven unique operating segments: Automotive, Food Equipment, Test & Measurement, Welding, Polymers & Fluids, Construction Products and Specialty Products. It generates more than half of its sales from international markets.
Illinois Tool Works is characterized by exemplary management, which invests great amounts on R&D year after year. As a result, the company has developed a broad portfolio of industrial products and has exhibited an exceptional performance record. Despite the inevitable cyclicality in its business, the industrial manufacturer has grown its earnings per share in seven of the last nine years, at an 8.5% average annual rate.
Moreover, Illinois Tool Works enjoys strong business momentum right now. It incurred a 14% decrease in its earnings per share in 2020 due to the unprecedented lockdowns caused by the pandemic, but it recovered strongly in 2021, with record EPS of $8.51, which were 10% higher than the pre-pandemic EPS of the company.
In the third quarter of 2022, the company grew its revenue 13% over the prior year's quarter thanks to double-digit growth in five of its seven segments. As a result, it grew its EPS 16%, from $2.02 to $2.35, and exceeded the analysts' estimates by $0.10. It has exceeded the analysts' consensus in 12 of the last 13 quarters and is on track to grow its EPS by about 11% this year, to a new all-time high.
Despite its inevitable sensitivity to recessions, Illinois Tool Works has raised its dividend for 58 consecutive years and hence it is a Dividend King. This is an admirable accomplishment for an industrial manufacturer. The company also has a payout ratio of 52% and a rock-solid balance sheet.
As a result, it can easily continue raising its dividend for many more years. Illinois Tool Works has grown its dividend by 13% per year on average over the last decade and over the last five years. This growth rate is much higher than the 8% median dividend growth rate of the entire industrial sector.
Therefore, while the current 2.4% dividend yield of Illinois Tool Works is lackluster on the surface, the stock is suitable for both growth-oriented and income-oriented investors with a long-term perspective.
Get Into Hot Water With an Aristocrat
A.O. Smith (AOS) is a leading manufacturer of residential and commercial water heaters, boilers and water treatment products. It generates approximately two-thirds of its sales in North America and the vast majority of the rest of its sales in China.
Due to the nature of its business, A.O. Smith is sensitive to the status of the housing market. The company has greatly benefited from the boom in the housing market, which has remained in place since the end of the Great Recession, in 2009.
A.O. Smith has also benefited from the immense growth potential in the Chinese market. It has grown its sales by about 20% per year on average in this country over the last decade. As a result, A.O. Smith has consistently grown its EPS almost every year over the last decade, at a 16% average annual rate. This growth rate combined with the consistent business performance are testaments to the strength of the business model of the company and its solid execution.
It is also worth noting that A.O. Smith currently generates a negligible amount of revenues in India but this country has similar growth potential to that of China. Therefore, the expansion of A.O. Smith in India may become a significant growth driver in the long run.
A.O. Smith is currently facing a strong headwind, namely the surge of inflation to a 40-year high, which exerts pressure on the margins of the company. In the third quarter, the earnings per share of A.O. Smith dipped 15% over the prior year's quarter, primarily due to the impact of inflation on the margins of the company and on consumer spending. Nevertheless, the company remains on track to grow its EPS by about 3% this year, to a new all-time high.
Thanks to its robust business model, A.O. Smith has grown its dividend for 29 consecutive years and hence it is a Dividend Aristocrat. It also has a healthy payout ratio of 39% and an almost debt-free balance sheet.
It can easily continue raising its dividend meaningfully for many more years. The company has grown its dividend by 20% per year on average over the last decade and by 15% per year on average over the last five years.
This means that income-oriented investors should not dismiss the stock for its modest current dividend yield of 2.0%, as the company is likely to more than double its dividend over the next 7-10 years.
Don't Duck This Dividend Grower
Founded in 1955, Aflac (AFL) is the largest underwriter of supplemental cancer insurance in the world. The insurance company also provides accident, short-term disability, critical illness, dental, vision, and life insurance. Aflac generates approximately 70% of its pretax earnings from Japan and the remaining 30% from the U.S.
Aflac operates in two developed, mature countries and hence its growth potential is somewhat limited. Nevertheless, the company has exhibited a solid performance record. During the last decade, the insurer has never incurred a material decrease in its earnings per share and has grown its earnings per share at an 8.3% average annual rate.
Aflac was hurt by the nearly record-low interest rates that prevailed throughout the last 13 years, until this year. The depressed interest rates took their toll on the investment income of the insurer, whose portfolio includes primarily bonds. However, the Fed is currently raising interest rates aggressively in order to restore inflation to its long-term target around 2%.
Aflac has begun to invest its float at higher rates and thus it is likely to grow its investment income in the upcoming quarters. The tailwind from rising interest rates helps explain why the stock of Aflac is currently trading at a 10-year high price-to-earnings ratio of 13.3. To provide a perspective, the stock traded at a price-to-earnings ratio close to 10 during 2012-2021.
Aflac is not immune to recessions but it is fairly resilient, as evidenced by the 20% decrease in its EPS in the Great Recession, the worst financial crisis of the last 90 years. Its stock price collapsed during the Great Recession, from $34 to $6, but the investors who remained focused on the solid fundamentals of the insurer were vindicated, as the stock retrieved nearly all its losses in 2009-2010.
The company has an exceptional dividend growth record, with 41 consecutive years of dividend raises. The company has grown its dividend by 9% per year on average over the last decade and by 13% per year on average over the last five years. Given also its solid payout ratio of 32% and its defensive business model, investors should rest assured that the company will continue raising its dividend meaningfully for many more years.
Final Thoughts
The above three stocks boast exceptional dividend growth records thanks to the reliable growth trajectories of their earnings. Thanks to their strong business models, they have rock-solid balance sheets. Given also their healthy payout ratios and their reliable business performance, investors should rest assured that these companies will continue raising their dividends for the next several years.
Income investors should consider participating in their DRIP plans, which maximize the compounding effect of reinvested dividends.
