Follow the Money, Trade the Trend

A dividend growth stock is a type of equity investment that consistently increases its dividend payments over time, offering investors a growing stream of passive income. The key characteristic of such a stock is its dividend growth percentage, which reflects how much the dividend has increased year-over-year. Ideally, a dividend growth stock will show a three-year and five-year dividend growth rate of at least 10% annually. These increases can be an indicator of the company’s financial health, long-term profitability, and commitment to returning value to shareholders. The dividend growth rate should consistently outpace inflation, offering investors a hedge against rising living costs.

A crucial feature of a strong dividend growth stock is a low payout ratio, which is the percentage of earnings the company pays out as dividends. A low payout ratio suggests that the company retains enough earnings to reinvest in its operations, fund growth initiatives, or weather economic downturns without compromising its dividend payments. A payout ratio between 30% and 60% is often considered ideal, as it leaves room for future dividend increases and ensures the company isn’t overly reliant on dividends to attract investors*.

• Companies that own real estate/alternative assets can afford a higher payout ratio than typical equities due to their business model, which focuses on generating substantial cash flow through private equity, real estate investments, and other alternative assets.

Finally, for a stock to be considered a solid dividend growth investment, its return on equity (ROE) should ideally exceed the dividend growth rate. A higher ROE indicates that the company is efficiently using its equity to generate profits, which is essential for sustaining dividend growth over time. Consistency in dividend growth is paramount, as companies that can increase their dividends reliably, even during challenging economic periods, demonstrate strong management and financial stability. For investors, this consistency not only provides a reliable income stream but also often results in long-term capital appreciation as the company’s reputation for steady growth becomes a competitive advantage.

So which stocks meet this criteria and are on sale? 

Murphy USA (MUSA), Blackstone (BX) and UnitedHealthcare (UNH) are three stocks I’m watching that meet the above mentioned dividend growth requirements. With the broader market experiencing weakness, drilling down to individual equities provides an opportunity to buy strong companies at cheaper prices. 

Murphy USA (MUSA) operates a chain of retail gas stations and convenience stores across the United States. The company primarily focuses on selling gasoline and diesel fuel, while also offering a variety of convenience store products such as snacks, beverages, and tobacco. Known for its strong retail network, Murphy USA partners with major oil companies, positioning itself as a low-cost fuel provider with a focus on customer convenience and value.

Chart 1.1: MUSA’s Financials

MUSA began paying a dividend in 2020 and has consistently delivered since then. With an impressive three-year dividend growth rate of 19.84%, the company’s commitment to increasing distributions highlights its exceptional management and operational prowess. This rapid growth in dividends is sustainable, as it doesn’t strain the company’s cash flow—MUSA maintains a low payout ratio of just 7.42%, leaving over 90% of its cash available for reinvestment in the business.

Fueling its growth, MUSA boasts a return on equity (ROE) of 60%, demonstrating its ability to generate substantial cash flow without relying on additional investor capital. This strong ROE reflects the company’s efficiency and capacity to drive value for shareholders while reinvesting in future growth opportunities.

Blackstone (BX) is a global investment firm specializing in alternative assets, including private equity, real estate, credit, and hedge fund solutions. The company manages a diverse portfolio of investments across various sectors and industries, leveraging its expertise to generate value for institutional and individual investors. Blackstone’s business model focuses on creating long-term capital appreciation and consistent income through its strategic investments and global market presence.

Chart 1.2: BX’s Financials

BX runs somewhat counter to the typical requirement of consistent dividend growth and a low payout ratio, but this is due to its unique business model, which differs from companies with a more linear growth trajectory. BX has historically adjusted its dividend payout to align with the company’s earnings and investment performance, as its income can fluctuate due to the nature of its investments. As a private equity firm, BX generates income from various alternative asset classes, and the timing and size of returns can vary widely, leading to periodic adjustments in its dividend. This approach reflects the firm’s focus on generating substantial capital appreciation and returns over time, rather than offering steady, predictable payouts.

Despite these fluctuations, BX maintains a strong average dividend yield greater than 2.75%, which is competitive within its sector. The firm also boasts a robust return on equity (ROE), a testament to its operational efficiency and ability to generate returns for investors. As a leader in the alternative asset space, BX is well-positioned to continue driving value through its diverse portfolio, offering investors the potential for significant long-term growth, even if its dividend payouts are less predictable. 

UnitedHealth Group (UNH) is a leading healthcare company that offers a wide range of services, including health insurance, health management, and healthcare technology solutions. The company operates through two main segments: UnitedHealthcare, which provides insurance and health benefits, and Optum, a health services division focused on healthcare delivery, data analytics, and pharmacy care. UnitedHealth’s diversified business model positions it as a key player in the healthcare sector, providing services to individuals, employers, and healthcare providers alike.

Chart 1.3: UNH’s Financials 

Of the three stocks mentioned in this article, I consider UnitedHealth Group (UNH) the riskiest. The ongoing investigation by the U.S. Department of Justice could potentially disrupt the company’s operations and performance, but if these concerns turn out to be unfounded, the current entry price could present a significant opportunity for investors.

UNH has a strong history of dividend growth, with a 3-year growth rate of 13.46%. Although its payout ratio recently spiked to 50%, the 3-year average of 33.57% suggests this is likely a temporary trend, and as long as the higher ratio doesn’t persist, there’s little cause for concern. The company’s operations remain solid, with a return on equity (ROE) of 26%, well above the industry average of 8%, further cementing its position as an industry leader.

To put UNH’s recent selloff into perspective, it’s important to note that the entire health insurance sector has experienced a sharp decline in market capitalization. Cigna, Humana, and Centene have all faced similar downtrends, indicating that the broader industry is struggling, not just UNH. As the largest player in the space, UNH is naturally drawing the most attention, but this selloff is reflective of industry-wide challenges.

DISCLAIMER:

I am not a registered or certified financial advisor. Nothing in this blog constitutes a recommendation to buy or sell any security listed in this blog post. All blog posts are for educational purposes on;y. Do your own due diligence.