The Dividend Aristocrats are among the highest-quality stocks an investor can buy for the long-term. The Dividend Kings are even more impressive. While the Dividend Aristocrats have raised their dividends for at least 25 consecutive years, the Dividend Kings have maintained 50+ years of dividend growth.
Illinois Tool Works (ITW) has increased its dividend for 55 consecutive years, including a 28% increase in 2018. It has more than doubled its quarterly dividend in the past five years, from $0.42 to $1.00 per share. The impressive dividend history is due to the company's dominant market position and commitment to innovation.
Shares of Illinois Tool Works currently yield 3.0% right now, a strong payout for a time-tested Dividend King. Some stocks offer high dividend yields but low-to-no growth, while other stocks have high dividend growth but paltry dividend yields. Illinois Tool Works is a rare stock that combines a high dividend yield with high dividend growth.
Diversified Products and Market Leadership
Illinois Tool Works is a global multi-industrial manufacturer. The company generates annual revenue in excess of $14 billion, and the stock has a market capitalization of $43 billion. Illinois Tool Works operates seven business segments: Automotive; Food Equipment; Test & Measurement and Electronics; Welding; Polymers & Fluids; Construction Products; and Specialty Products.
The Glenview, Illinois-based company has a highly focused set of criteria for its business portfolio. It looks to enter end markets that offer an opportunity for sustainable differentiation. End markets must have positive long-term macroeconomic fundamentals, offer the potential for durable competitive advantages, with access to long-term growth trends.
All seven of Illinois Tool Works' operating segments generated positive organic revenue growth over the first three quarters of 2018, led by Welding with 10.4% revenue growth. The key to Illinois Tool Works' strong financial performance and steady growth over so many years is the company's disciplined approach to capital allocation. The company spends 25%-30% of its annual operating cash flow on internal investments, including growth initiatives to sustain the core business. Its willingness to invest heavily in growth provides the innovation that allows it to lead all seven of its product categories.
On top of this, the company allocates 30% to 40% of its annual operating cash flow to external investments, such as acquisitions. This gives it the ability to pursue growth in a new business area if it chooses to. The remaining portion of operating cash flow, roughly 40%, is used to pay dividends to shareholders.
In the third quarter, Illinois Tool Works generated $3.6 billion of revenue, representing organic revenue growth of 2%. North America led the way with 4% organic growth. Operating margin widened by 30 basis points to 24.6%. Cost cuts implemented by the company's cost-cutting initiative, called Enterprise Initiatives, contributed 100 basis points of margin expansion. Furthermore, the company was able to absorb higher raw materials costs through pricing increases.
The combination of revenue growth and margin expansion resulted in 11% earnings growth for the third quarter. Illinois Tool Works continues to generate strong cash flow. Free cash flow increased 17% in the third quarter. Illinois Tool Works grew its EPS at a compound annual rate of 9.0% per year since 2008. The company is scheduled to report fourth-quarter results on Feb. 1.
The company now expects 15% full-year EPS growth for 2019, and has guided for 8%-10% annual EPS growth through 2022. The positive future growth outlook allows the company to continue rewarding shareholders with cash returns.
Last quarter, Illinois Tool Works repurchased $500 million of its own stock. In 2018 the company also raised its dividend by 28%. Along with the dividend hike, the company approved a new share repurchase program that authorizes up to $3 billion of buybacks, on top of the $1.4 billion remaining from the previous unfinished authorization. The $4.4 billion of share buybacks represents over 10% of the company's current market capitalization.
These repurchases could lead to a significant boost for Illinois Tool Works' future EPS growth. Share buybacks help grow EPS, as a lower number of shares outstanding results in greater value for the remaining shares. If Illinois Tool Works takes three years to complete the new share repurchase authorization, it could add more than 3% to EPS growth each year.
The company's dividend is highly secure. Illinois Tool Works maintains a target dividend payout ratio of roughly 40%. This is a modest payout ratio which leaves room for future increases, even in difficult years in which EPS growth is hard to manufacture. This is how Illinois Tool Works managed to increase its dividend each year for more than 50 years in row, even during recessions.
Illinois Tool Works is not immune to recessions. For example, in 2009 the company's EPS declined by 37% from 2008. As a global manufacturer, the company is closely tied to the global economy. However, Illinois Tool Works remained profitable during the Great Recession, and the company quickly recovered in the following years. EPS increased 57% in 2010 and 23% in 2011.
Industrial manufacturer stocks tend to fly under the radar. But dividend growth investors should not overlook the industrial sector, as it is a rich source of dividend growth stocks.
Illinois Tool Works is an example of a high-quality Dividend King. It has rewarded shareholders with annual dividend increases for over five decades. Due to the company's strong business model and long-term growth potential, it should continue to raise its dividend each year like clockwork. With a current yield around 3%, Illinois Tool Works is an attractive stock for yield and dividend growth.
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