5 Hot Dividend Picks From Income-Focused Mutual Funds: Part II

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In Part I of this series, we discussed three hot dividend picks that professional mutual funds have loved lately. Dividend growth investing has been especially appealing for income investors in the low-yield environment, in addition to this particular market-beating strategy. All these stocks yield more than 2% and are selected for review due to their dividend growth potential.

Let’s take a look at the final two on our list, but first, we’ll start with some bonus analysis of Walgreen (NYSE: WAG), which was number three on our list in Part I.

Bonus

Walgreen's sales in the fiscal third quarter, ending May 31, increased 3.3% year-over-year, with comparable store sales up 1.3% and prescriptions filled at comparable stores up 7% from the year earlier. Monthly sales indicate a rising momentum, as May sales rose 4.3% year-over-year, above the quarterly average, and total sales in comparable stores increased 2.8%. Prescriptions filled at comparable stores were up 7.1%, and would have been even higher without the adverse impact of the calendar shifts.

The company has embarked on new initiatives that are likely to boost its financial performance. Walgreen’s earlier-announced 10-year supply partnership with AmerisourceBergen will be beneficial to both parties in terms of sales and earnings. Moreover, it gives Walgreen and Alliance Boots the right to purchase up to 7% of AmerisourceBergen’s stock in the open market, as well as warrants exercisable for 16% in the aggregate of AmerisourceBergen’s equity.

In addition to this deal and Alliance Boots’ synergies, the company’s long-term prospects are supported by an aging population, accretion from the implementation of the healthcare reform, higher healthcare spending, greater penetration of generic drugs with higher margins, and emerging market expansion.

Next up

Ford (NYSE: F), the second biggest U.S. automaker by market share, is also one of the recent dividend growth picks of income mutual funds. The company has seen a major sales turnaround in the United States, where, last month, it posted its best May new-vehicle sales tally in years. In fact, Ford’s 14% gain in U.S. vehicle sales in May made for the best May since 2006. The F-series pickup trucks posted a 31% increase over the past year. The robust U.S. demand is supported by the U.S. energy boom and recovering construction markets, including the housing market’s expansion. The trends are also positive because of a pent-up replacement demand, as the age of the U.S. passenger fleet hovers around record-high levels.

Interestingly, demand for Ford’s hybrid models is particularly robust this year -- the automaker has sold more hybrid vehicles this year than it has in any full year, breaking the full-year record set in 2010. These positive sales dynamics are helping Ford increase its U.S. market share and are prompting production increases. As a result, last quarter, the company posted its 15th consecutive quarter of profitability.

However, the environment remains challenging in many markets outside the United States. In Europe, the company is enduring losses, but the outlook is improving, with expectations the company’s European operations will break-even within two years. In the Asia-Pacific-Africa region, Ford looks to break-even this year, reflecting strong growth in volume, market share, and revenue. The rebound in global economies, and especially the rising middle class in emerging markets, bode well for the automaker’s growth potential in the long run. This is reflected in the company’s China growth, where May sales rose 45% from the year-ago levels, breaking records in passenger vehicle sales.

There are also several additional positives about Ford. Ford’s competitive edge over competitors rests with its short product cycle and the capacity to introduce new models faster than competitors. The company has achieved 12 consecutive quarters of positive cash flow. It boasts a solid balance sheet, with 17.8% of its assets in cash and short-term investments and net receivables that cover almost 80% of the company’s long-term debt. Ford’s stock is cheap at 9.2x forward earnings, especially given its 2.6% dividend yield (with a low payout ratio of 28% of the current-year EPS estimate) and the forecast of long-term EPS CAGR of 11.9%.

The best of the rest

ACE Limited (NYSE: ACE), one of the world’s largest multi-line insurance providers, boasts dividend growth potential, following an increase in the company’s dividend by 4.1% in May. As a result, the current yield stands at 2.3%, while its payout ratio is low at 25% of the current-year EPS estimate. However, it should still be considered that the company’s strategy to grow through acquisitions could claim a notable portion of available cash flow to fund expansion.

The long-term profitability outlook for the company is positive, as analysts see its long-term EPS CAGR at 8.1%. For reference, the company’s net written premiums grew 5% last year, while adjusted diluted EPS was up 12%.

This insurer has a strong competitive position in its industry, characterized by operating outperformance relative to its peers and a focus on underwriting discipline. Its operating ROE has been consistently higher than the comparable metric for its peers on average. (The company targets a long-term ROE of 15%, which it is expected to reach within two years.) On the other hand, its P&C combined ratio has been consistently lower than that of its peers on average.

Operating in 53 countries, ACE has a broad geographical reach and offers a diversified portfolio of products, which adds to its strength. While low interest rates and rising operating expenses have weighed on the insurer’s financial performance in recent years, the prospect of rising interest rates provides some support to improved investment income outlook for the upcoming period. It also lends support to expectations of a higher ROE. In fact, every 100 basis points move in its portfolio book yield is worth almost 2 points of ROE.

The company’s strategy has been to channel excess cash into reinvestments, including acquisitions, instead of share buybacks. Therefore, the company has grown in scale and scope, with accretive acquisitions that have been supporting ROE expansion. Still, as of the end of the first quarter, the company had some $307 million in share buyback authorizations. Moreover, the company has been building shareholder wealth through growth in book value, which has increased by nearly 360% over the past decade. ACE’s focus on growth, including both organic and acquisitive growth, with robust ROE targets, points at potential for continued future outperformance.

Final thoughts

The aforementioned companies -- Ford, ACE, and Walgreen -- each represent intriguing situations worth watching, and their support from mutual funds warrants closer inspection. 

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This article is written by Serkan Unal and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool recommends Ford. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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