Invest In The Best: 2 Dividend Growth Stocks To Hold Forever
Are you tired of the current market volatility affecting your portfolio?
Fear not, because in this article, I’m going to introduce you to two fantastic dividend growth stocks that are sure to weather almost any market storm. These stocks offer consistent and sustainable dividend hikes, making them ideal long-term investments that could potentially outperform the market with subdued volatility. Thanks to these characteristics, I’ve personally added both of these stocks to my watchlist and various model portfolios.
But before we dive into the specifics, let’s review the exciting theoretical background on the power of dividend growth investing!
Dividend Growth Investing Makes Sense
Dividends are important. According to Hartford Funds, since 1960, 69% of the total return of the S&P 500 came from reinvested dividends. $10,000 invested in 1960 would have turned into $4.1 million in 2022 in a scenario of consistent dividend reinvestments. Without dividends, that number would have been just $641,000.
Even better, companies that consistently grow their dividends are the best-performing stocks on the market, beating non-growing dividend payers by a mile. And even non-growing dividend payers beat the equal-weighted S&P 500 by a wide margin.
In other words, while dividends are important, dividend growth is the place to be.
But wait, there’s more evidence. In 2009, an article was published in The Journal of Wealth Management titled Consistent Dividend Growth Investment Strategies.
This paper focused on a sample of stocks in the United Kingdom between 1986 and 2006.
The findings of the paper were in line with the research we just discussed. Moreover, the paper added a few interesting details I hadn’t found in other articles. I highlight these details below.
- Consistent dividend payers have outperformed the wider market on an equally weighted basis for 1986-2006, particularly when the minimum requirement is set at ten years of continuous growth.
- These stocks have lower variance of returns and have suffered smaller drawdowns over shorter durations.
- Market-capitalization weighted portfolios did not offer the same benefits as equally weighted portfolios, possibly due to a loss of diversification as a few large stocks dominated.
- Zero-dividend firms have demonstrated relatively poor returns and higher volatility than dividend-paying firms.
The table below shows some of the findings. Whether it’s the all-share FTSE or the data from the London Share Price Database (“LSPD”), we see that stocks with a consistent dividend growth track record tend to have a higher total return, lower volatility, and (related) a better risk-adjusted return.
While a lot depends on diversification (which is why I will keep covering it in future articles), we can assume that our portfolios will do well if we keep buying high-quality dividend growth stocks.
So, let me present two stocks that are likely to get the job done, as they come with at least ten years of consistent dividend growth.
Waste Management (WM)
Turning waste into wealth with consistent dividend growth.
- Sector: Industrials
- Industry: Waste Management
- Dividend Yield: 1.8%
- 5Y Dividend CAGR: 8.8%
Waste Management is a fantastic example of why investors don’t need to invest in the hottest tech trends to build wealth.
Incorporated in Oklahoma in 1987, WM has become North America’s leading provider of comprehensive environmental solutions, providing services throughout the United States and Canada.
The company manages waste at every stage, from collection to disposal and renewable energy. Waste Management operates through subsidiaries that focus on distinct geographic areas, providing collection, transfer, disposal, recycling, and resource recovery services on more than 15,500 collection routes.
Waste Management is also a leading recycler in the US and Canada, handling materials that include cardboard, paper, glass, plastic, and metal. The company provides cost-efficient and environmentally sound recycling programs for municipalities, businesses, and households, along with other services that supplement its Solid Waste business.
On a full-year basis (using 2021 data), the company generates slightly more than half of its revenues in waste collection. This includes picking up waste and recyclables and transporting it to transfer stations, landfills, material recovery facilities, and other outlets.
The company’s business model benefits from both volume growth and pricing benefits.
During the J.P. Morgan Industrial Conference earlier this month, the company mentioned how it is handling pricing in the current high-inflation environment.
In recent years, the company has taken a deeper look into its post-collection practices, including the pricing for landfills and transfer stations. With 260 landfills and 350 transfer facilities, Waste Management is well-positioned to move waste efficiently and serve its customers’ needs. However, the company saw inflationary pressures on the costs of constructing and developing these landfill assets. The residential line of business is particularly labor-intensive, leading to cost pressures, and the company has sacrificed volume to maintain margins and returns. Despite seeing a volume decline of over 3% in the last quarter, the company is focused on ensuring the residential line of business can compete with its other lines in terms of return and margin.
In its 4Q22 quarter, the company generated 8.1% core price growth. Total volumes were down 0.7% (down 0.4% adjusted for missing work days). On a full-year basis, volumes were up 1.3%.
The company efficiently managed rising costs, proving that its focus on pricing is working.
In the fourth quarter of 2022, operating expenses as a percentage of revenue were 62.7%, which is an improvement compared to 63.2% in the same period of 2021. This improvement was driven by the collection and disposal business, which overcame inflationary cost pressures through pricing and operating efficiencies. Higher fuel prices had a negative impact of 40 basis points, while the recycling business had a negative impact of 30 basis points.
Furthermore, when it comes to growth opportunities, Jonathan Wheeler writes:
Eventually, the company will run out of smaller operators to gobble up and that will cause growth to slow. However, the company has no shortage of places to invest its cash. RNG produced naturally by the company’s landfills has been used to power 74% of the company’s truck fleet and is sold to the grid. Government regulation is moving in the direction of requiring some amount of RNG use by utilities, and with the company’s classification of RNG as a renewable energy source, future legislation benefitting all the renewables will likely favor WM.
Based on this context, the company’s qualities have resulted in steady and high dividend growth. In 2004, the company paid $0.75 per share. That number rose to $2.60 in 2022 without any cuts.
In February, management announced a dividend hike of 7.7% to $0.70 per share per quarter, which translates to $2.80 per year. This gives the company a 1.8% yield.
Over the past five years, the average annual dividend growth rate was 8.8%. The company has hiked its dividend for 19 consecutive years.
The only thing worth noting is that the company scores relatively low when it comes to its dividend yield. 1.8% is a dealbreaker to some, as it’s far from a satisfying yield. However, it needs to be said that the sector median dividend yield is 1.7%. In other words, the company doesn’t even score poorly compared to the industrial sector. It mainly scores poorly compared to high-yield investments with juicy yields. Most of these investments do not come with high dividend growth.
Dividend safety is also high. The payout ratio is 47%. As the dividend history chart above shows, the company has just one year with an elevated payout ratio (2012).
Moreover, shares are trading at 14.5x EBITDA (13.1x NMT EBITDA). This valuation is fair, as marked woes have pushed the share price 13% below its 52-week high.
Now, before I show you the historical performance of its stock price (including its low-volatility profile), let’s visit stock number two.
Digital Realty (DLR)
A perfect real estate mix between growth and high yield.
- Sector: Real Estate
- Industry: REIT – Specialty
- 5.2% dividend yield.
- 5Y dividend CAGR: 5.1%
Digital Realty is one of the companies that I should have covered way more in the past, as it brings a lot of value to the table. That said, the current valuation offers a great opportunity to shed some light on this real estate giant.
Digital Realty was founded in 2004. Headquartered in Austin, Texas, the company invests in carrier-neutral data centers and provides colocation and peering services.
As of December 31, 2022, the company owns 316 data centers. The majority of these assets are located in the United States, followed by Europe and APAC nations.
Most of these assets are focused on cloud infrastructure and are owned by the company. Half of its customers have investment-grade balance sheets.
As (rapid) organic growth is tough to achieve, the company has a history of aggressive M&A, allowing it to expand its footprint in its main market and growth markets like Asia and South America.
The company’s assets are supported by its propriety technology.
PlatformDIGITAL is their global data center platform for scaling digital business that combines their global presence with their Pervasive Data Center Architecture (“PDx”) solution methodology to solve global coverage, capacity, and connectivity needs for companies of all sizes, including the world’s leading enterprises and services providers. They bring together foundational real estate and innovative technology expertise to meet customers’ data and connectivity needs.
In other words, it’s a fancy way of saying that it operates the assets that allow players to expand their global footprint. This includes benefiting from high secular growth.
Cloud computing, streaming, e-commerce, enterprise modernization, 5G, the Internet of Things, and artificial intelligence are just a few examples of massive secular trends boosting the high demand for data centers.
The company’s largest customer accounts for 10.2% of annual recurring revenue. This company is an anonymous Fortune 500 software company renting 65 locations. The second-largest customer is IBM (IBM), which accounts for 3.6% of annual recurring revenue. While its largest tenant is clearly powerful, the company has a well-diversified customer portfolio.
Based on these industry trends, digital infrastructure demand is expected to grow by 10% per year between 2022 and 2026.
Needless to say, the company is dependent on external funding to fund its operations.
Since 2009, the company has raised $27 billion through a mix of equity issuance (the opposite of buybacks), dispositions, and preferred equity. On top of that, the company has issued bonds in EUR, USD, GBP, and CHF.
Despite massive equity issuance, the company has generated tremendous value for its shareholders. The PER SHARE value of its funds from operations has consistently improved, even during recessions, as its secular growth business model is (somewhat) recession-proof.
That said, the company has somewhat elevated debt. As of 4Q22, the company had a net leverage ratio of 6.9x, which is elevated. Yet, the company is upbeat when it comes to the current high-rate environment.
This is what the company said in its 4Q22 earnings call:
While leverage is above our historical average and our long-term target, we have bolstered our liquidity, and we intend to reduce leverage towards our long-term target over the course of 2023. Our weighted average debt maturity is over 5 years, and our weighted average coupon is 2.7%. Approximately 86% of our debt is non-U.S. dollar denominated, reflecting the growth of our global platform. Over 80% of our net debt is fixed rate and 97% of our debt is unsecured, providing ample flexibility for capital recycling. Finally, we have minimal near-term debt maturities with only $100 million maturing in 2023, together with a well-laddered maturity schedule.
In other words, the company is still in a good situation, despite the current high-rate environment. This is confirmed by its BBB-rated balance sheet.
When it comes to (financial) stability, it also needs to be said that the weighted average remaining lease term is 4.7 years. Moreover, because the company is in a good position thanks to terrific assets and somewhat limited competition, it can charge higher rates on renewals. In 2023, the goal is to hike rates on renewals by at least 3%.
Over the past 12 months, the company has retained 90% of its customers. The long-term average is close to 80%.
With that said, DLR has a terrific dividend.
Since 2005, the company has raised its dividend by 10% per year – without any cuts! Over the past five years, average annual dividend growth has fallen to 5.1%. The company’s payout ratio has consistently hovered close to the 70% to 80% range. The stock currently yields 5.2%, which makes it a high-yield investment with above-average (expected) dividend growth.
Despite the good news, the stock is now 38% below its 52-week high. High inflation and the related surge in interest rates are toxic for most real estate stocks – even the strongest players on the market. High inflation reduces pricing power, while high rates make aggressive growth riskier (expensive). The low-rate environment prior to 2022 was perfect for DLR, as it allowed the company to benefit from high secular growth without having to deal with higher rates to expand. Between 2014 and 2022, the stock price soared from $40 to $180. Now it’s back below $100.
The company is currently trading at 15x forward adjusted FFO. The sector median is 14.0x, which makes the relative valuation of DLR attractive.
The Bottom Line & Takeaway
We started this article by discussing the benefits of dividend growth investing. When done correctly, a well-diversified portfolio of dividend growth stocks outperforms the market with subdued volatility. This is caused by the high-quality aspect that makes consistent dividend growth possible in the first place. Even if dividend growth stocks do not outperform during every bull market, downside protection during bear markets is often enough to beat the market on a long-term basis.
Hence, in this article, I presented two stocks with stellar long-term dividend growth backed by wide-moat business models.
I put both stocks in my model portfolios and on my watchlist, as I am looking to add them to my portfolio when the opportunity presents itself.
That said, to prove the theories we discussed in this article, we can use the data below. We see that both stocks outperform the market with subdued volatility. Going back to 2005, both WM and DLR have outperformed the market, returning 12.4% and 16.5% per year, respectively. Moreover, both have more favorable Sharpe Ratios (risk-adjusted returns) and market correlations of less than 60%.
However, due to rising rates, DLR has become an underperformer in recent years. Over the past five years, DLR shares have returned 4.3% per year with a standard deviation of 30%. That is less favorable.
The good news is that DLR is now trading at a favorable valuation and poised to do rather well on a long-term basis. Hence, I expect that on a long-term basis, DLR shares will continue outperforming the market.
With all of this in mind, investors looking for high-quality dividend growth may want to consider taking a closer look at WM and DLR.
Going forward, we’ll continue to discuss attractive investment opportunities, so don’t hold back if you have suggestions! Also, please let me know what you think of these two stocks.