This post was first published on my blog - here is the link to the original post https://topcornerinvesting.wordpress.com/2022/12/23/5-dividend-growth-stocks-to-consider-why/

Great dividend growth companies tick off a lot of the same boxes that “high-quality” companies do - typically solid balance sheets, growing free cash flows that allow the companies to increase dividend payments as well as a history of good financial performance.

The best example of this is the fact that the Dividend Aristocrats index (companies that have increased their dividends annually for at least 25 years) outperformed the S&P 500 between 2003 and 2021 (source.) The most important lesson here is that it is possible to get the best of both worlds - growing dividends as well as stock price appreciation - if you can find the right companies.

Below are 5 companies that should be in your investing universe - whether you are looking for high quality or dividend growth.

Dividend Growth CAGR (5 year) – 10.3%

Years of Dividend Growth – 9

EPS growth CAGR (10 year) – 13.3%

Payout ratio – 60%

Dividend yield – 3.5%

Watsco is a $9.9 billion market cap distributor of HVAC (heating, ventilation, air conditioning.) It is the market leader in a “boring” and fragmented industry, which Watsco is transforming through its digital experience. This will help Watsco’s customers (typically contractors) deliver parts and units faster & strengthen the relationship between supplier and contractors, a win for both parties.

Revenues have been growing mostly in the single-digits over the past decade, with the exception of 2021 with the pandemic induced boom in home spend. Even if revenue growth reverts to its mean over the next year or so, Watsco is benefitting from tailwinds such as a growing installed base (to repair and maintain), e-commerce, and the transition to cleaner and more efficient units. Add a 3.5% dividend yield to that and Watsco could be worth further consideration for dividend growth investors.

From Watsco Investor Presentation (Q3 2022)

If you want to learn more about Watsco, check out the Twitter thread from @ifb_podcast here.

Dividend Growth CAGR (5 year) – 15.0%

Years of Dividend Growth – 12

EPS growth CAGR (10 year) – 11.8%

Payout ratio – ~44%

Dividend yield – 2.40%

No need to introduce The Home Depot. It’s a very resilient business that caters to both do-it-yourself customers as well as pros. Compared to Lowe's, the main competitor, Home Depot earns more revenue from pros. This tends to be more recurring and also gives Home Depot the benefit of high switching costs as these pros know and rely on the supplies and tools. However, both are great companies with scale advantages and a dominant position in the home improvement industry.

>40% ROIC over the past three years (per 2021 annual report) means that there are attractive opportunities for Home Depot to allocate capital and that management has been doing so efficiently. In addition to the dividend Home Depot has been paying a dividend for more than a decade, the company also repurchased ~$15B worth of shares in fiscal year 2021.

To learn more about Home Depot, I recommend the deep dive from The Science of Hitting (Alex Morris) and this episode from Business Breakdowns.

Dividend Growth CAGR (5 year) – 23.0%

Years of Dividend Growth – 8

EPS growth CAGR (10 year) – 18.0%

Payout ratio – 41.7%

Dividend yield – 1.06%

MSCI’s numbers tell you a lot about the quality of the company. 13% annual compound growth in free cash flow over the past 10 years and widening margins as well as double-digit dividend growth. The dividend yield is low, but MSCI has also crushed the market on a 5, 10 and 15 year basis. Recurring revenue and a capital light business model means a lot of the cash can be invested in further growth or given back to shareholders.

Dividend Growth CAGR (5 year) – 6.58%

Years of Dividend Growth – 3 (in my defense, dividend per share went from $3 in 2013 to $11 in 2021)

EPS growth CAGR (10 year) – 14.4%

Payout ratio – 44.9%

Dividend yield – 2.33%

TSM might not really count as a dividend growth company, but I wanted to include them because of the moat and exposure to the growing semiconductor industry. There’s a reason Warren Buffett recently invested in TSM. However, there are many other options in the semiconductor industry one could choose (Texas Instruments, Qualcomm, ASML, Nvidia etc.) See the overview of the chip ecosystem below.

TSM is a pure play on chip manufacturing. While this is an asset heavy company, competitors face extremely high barriers to enter because of the intangible assets that TSM has developed. If you are bullish on the semiconductor industry overall but don’t want to be exposed to as much geopolitical uncertainty, there are plenty of different ways to play this trend as well.

(Source: @long_equity on Twitter)

This memo from TSM's own Investor Relations page outlines the bull thesis

Dividend Growth CAGR (5 year) – 12.0%

Years of Dividend Growth – >15

EPS growth CAGR (10 year) – 18.1%

Payout ratio – 26.8%

Dividend yield – 1.0%

The two credit rating agencies (S&P Global & Moody’s) are basically a duopoly with very solid competitive advantages and a product which other companies rely on. In addition to the credit rating, SPGI has several other segments such as Market Intelligence and the S&P Dow Jones Indices. These are generally stable industries that grow consistently and generate a lot of cash.

S&P Global is a dividend aristocrat and could continue to grow its dividend for many years given the large market share and strong competitive advantage. While it is a >$100B company and unlikely to provide similar returns as over the past decade (20.5% CAGR), S&P Global is a quality company.

To learn more about S&P Global, this piece from Value Investors Club is an excellent resource.

SPGI 2022 Investor Day

These are just a handful of the companies that could be included here - there is a lot of quality out there. Hopefully you got some value from this memo and maybe even a few new companies to research further!

As always, thanks for reading!