Investors looking for the best dividend growth stocks should first start with the list of Dividend Aristocrats. Of the 500 stocks that comprise the S&P 500 Index, only 57 -- barely more than 10% of the index -- qualify as Dividend Aristocrats.
To be a Dividend Aristocrat, a company must have raised its dividends paid to shareholders for at least 25 years in a row. This is no easy task. Recessions, competitive threats, and geopolitical strife are just a few of the potential risks that can easily derail even a strong company's dividend growth streak.
This is particularly true for stocks in the financial sector. The Great Recession of 2007-2009 forced many big U.S. banks to drastically cut their dividends. But People's United Financial (PBCT) is a rare financial sector stock that has increased its dividend for 25 consecutive years. People's United recently achieved status as a Dividend Aristocrat. Even better, the stock has a high dividend yield of 4.1%.
Conservative Business Model Produces Stability
People's United Financial operates People's United Bank, which was founded all the way back in 1842. Today, People's United Financial is a diversified financial services company. Its commercial segment provides commercial real estate lending, equipment financing, cash management, deposit gathering, and other services for businesses. Its retail arm offers mortgages, home equity lending, and other consumer loans, along with consumer deposits and merchant services. People's United also engages in life insurance, brokerage, wealth management, and financial advisory. The bank has a network of over 400 branches, with total assets of $48 billion and a market capitalization of $6 billion.
2018 was another year of steady growth for People's United. In the fourth quarter, People's United increased its earnings-per-share by 16% from the year-ago quarter, mostly due to the acquisition of First Connecticut and a boost from tax reform. The acquisition helped grow loans and deposits by 9% year over year. For the full year, earnings per share increased 26%. People's United had a Common Equity Tier 1 Ratio of 10.3%, indicating a strong business model and high return on equity.
People's United has a positive growth outlook going forward. Acquisitions will help it expand its geographic reach and customer base. People's United recently acquired VAR Technology Finance, which focuses on serving the technological sector. People's United also announced the acquisition of BSB Bancorp in November. This acquisition will enhance its presence in the New England region.
Aside from acquisitions, rising interest rates are a separate growth catalyst for People's United. Higher interest rates help banks increase profits from loans, while rates on deposits tend to increase much slower. To this end, People's United expanded its net interest margin by 5% last year, to 3.12%.
Financially Servicing Income Investors Since 1993
In 2018, People's United increased its dividend for the 25th year in a row, a streak of dividend growth going back to 1993. One reason for its ability to continue raising dividends throughout the Great Recession and beyond, is its relatively conservative management strategy.
People's United avoided many of the risky lending and trading practices that brought the U.S. financial system to the brink of collapse in 2008. For example, last quarter People's United had a very low net charge-off ratio of just 0.09%. While so many other large banks had to accept bailouts and slashed their dividends down to nearly zero in 2008-2009, People's United kept raising its dividend through the recession.
To be sure, People's United is not recession-resistant. As a financial services provider, its profits are highly correlated to economic growth. For example, from 2007- 2010, EPS declined 54% as the Great Recession took its toll. The key difference for People's United is that it remained profitable throughout, while so many other big banks posted huge losses. This allowed People's United to continue raising its dividend through the Great Recession.
Today, People's United has a secure dividend. The bank reported operating EPS of $1.31 in 2018; the current dividend payout stands at $0.70 per share, for a dividend payout ratio of 53%. A dividend payout ratio just above 50% indicates sufficient coverage of the current payout, as well as room to continue increasing the dividend each year going forward.
People's United is expected to generate EPS of $1.41 for 2019. Based on this, the stock trades for a price-to-earnings ratio of 12. Our fair value estimate is a price-to- earnings ratio of 13, which means the stock is modestly undervalued.
A higher stock valuation is warranted due to the company's future growth potential and long dividend history. Expansion of the valuation multiple could boost annual returns roughly 2.3% through 2023. Combining valuation changes with 5.0% expected annual earnings growth and the 4% dividend yield, expected total returns approach 11% per year for People's United stock over the next five years. This is a strong rate of return for the stock, and qualifies People's United as a buy for dividend growth and value investors.
There is nothing overly exciting about People's United or its business model. It is a slow-and-steady financial services company. But if the Great Recession taught income investors anything, it is that sometimes boring business models are the best stocks to buy.
People's United has one of the longest streaks of dividend growth in the entire financial sector. And today it has an dividend yield above 4%, which makes the stock especially attractive for income investors.
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