There’s no denying the appeal of dividend stocks that already offer huge yields. However, ignoring companies that offer smaller but rapidly expanding payouts can be a recipe for missing out on great income opportunities.
Stocks that are delivering robust dividend growth might not offer the biggest yields right now, but their returned-income trajectory suggests that shares purchased today will produce much bigger payouts down the line. That’s an attractive prospect for long-term investors who plan to reinvest their payouts and let the power of compounding benefit their portfolios. For investors seeking rapid dividend growth, Cisco Systems (NASDAQ: CSCO) and Apple (NASDAQ: AAPL) could feasibly double their payouts within the next five years and have the potential to deliver substantial capital appreciation.
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Cisco Systems has the right tailwinds
Following the passage of the Tax Cuts and Jobs Acts of 2017, Cisco management indicated that it would use the lower corporate tax rate and the opportunity to repatriate $67 billion of its offshore cash holdings at a lower rate to fund dividend increases, stock buybacks, and acquisitions. So far, the company appears to be making good on that promise.
Cisco has raised its payout 93% over the last five years, with its last payout boost arriving in February, coming in at a chunky 14%. Cisco also announced that it would be repurchasing an additional $25 billion of its own stock, which should help increase its payout over the long term by reducing the number of outstanding shares. The free-cash-flow (FCF) picture looks good as well, with the company generating roughly $12.7 billion in FCF over the trailing-12-month period, and the overall growth trajectory in recent years looking favorable.
Cisco has long been the dominant player in the router and switch networking hardware market, but has recently been moving to a more service-based business model. That’s come with some growing pains, but it stands to make the company’s business more dependable and profitable. And it provides insulation against scenarios in which more networking hardware is replicated through software, or the adoption of generic hardware accelerates at a significant pace. The company delivered 12% diluted earnings per share growth in its most recently reported quarter.
Shares trade at roughly 14.5 times this year’s expected earnings and yield roughly 3.1%, which is attractive for a stock that’s growing its dividend at such a rapid rate. Factor in the positive earnings catalyst coming from the company’s massive buyback push and the company’s potential to benefit from rapid growth for the number of connected devices in coming decades, and Cisco Systems appears to present a worthwhile opportunity for long-term shareholders.
Apple uses its brand strength
Like Cisco, Apple is taking advantage of the tax repatriation holiday for overseas cash that was offered through last year’s tax bill. The company plans to repatriate a whopping $245 billion, which will add roughly $207 billion after taxes to its American accounts. In addition to letting Apple expand its domestic operations, the favorable repatriation terms give the company even more leeway to fund dividend increases and stock buybacks.
Apple’s yield is a good bit smaller than Cisco’s, coming in at roughly 1.5%, but there’s a high likelihood that the Cupertino, California, company will continue to reward shareholders with rapid payout growth. The company delivered a 16% dividend increase in May, and the cost of distributing its current dividend still represents roughly a quarter of the company’s trailing FCF.
The iPhone maker’s fantastic brand strength allows it to command margins that are the envy of the consumer technology hardware industry, and this big advantage should allow it to continue expanding its dividend rapidly. The significance of the company’s high-value customer base isn’t limited to the hardware business, either.
Apple customers tend to spend significantly more on software purchases, creating a substantial tailwind for the company as it becomes increasingly focused on building out its app ecosystem and as users continue to spend more on third-party apps. In the company’s recently reported third-quarter results, sales for its services segment climbed 31% year over year to reach $9.5 billion, and played a substantial role in the 17% total revenue increase and 40% earnings growth.
There’s still significant potential for expansion in the hardware space as well. Apple trails far behind rivals Amazon and Alphabet in the smart-speaker space. But Apple’s brand power and design expertise suggest that it would be shortsighted to discount the company’s growth potential in the connected-home space. These advantages already appear to be helping it consistently gain ground in the wearables market.
Priced at roughly 16.5 times this year’s expected earnings, Apple is still a smart buy for investors seeking earnings and dividend growth.
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Keith Noonan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.
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