Buy These Names Before They Increase Their Dividends

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

Recently, some hard-line retailers have been raising their dividends, which has led to exceptional share price increases. Two of the most important examples are increases in dividends announced by Nike and Williams-Sonoma in March. Since then both stocks have been up by 12% and 24%, respectively. However, an interesting note for investors is that some retailers are just around the corner from announcing dividend hikes, which has obviously not been factored into the stock prices given that investors have been holding back on the stocks amidst uncertainty.

Why should these companies announce dividend hikes?

Companies with solid recurring free cash flow combined with low (or no) current dividend payout ratios are destined to increase their dividends. Currently, within hard lines, four companies already pay dividends with yields above the Treasury rate (Best Buy, Home Depot, Staples, and Williams-Sonoma). However, taking a lesson from Williams-Sonoma, whose recent dividend increase was applauded by the market, it may make sense for others to follow suit. Hence, with the 10-year Treasury yielding 2.3%, dividends represent an increasingly attractive way to generate investment return.

Moreover, higher yielding stocks are currently being rewarded with better valuations. Across consumer segments, high dividend-yielding stocks (which are defined as having yields above 2.5%) are currently commanding PEG (Price/Earnings to Growth) multiples 37% higher than low-yield names.

Which companies?

Up until now, I haven’t disclosed which companies are likely to announce dividend hikes. Let’s have a look at four potential players:

The analysis across the consumer-goods sector screens us the best four companies that are possibly expected to raise their dividends in the near future, which will serve as a potential catalyst for stock-price movement.

Staples (NASDAQ: SPLS) has been viewed as a favorable company by investors after the merger of Office Max and Office Depot. On May 22, Staples reported another weak quarter, as top-line sluggishness could not make up for pricing declines and investments in infrastructure in contracts.

The company appears to have changed its strategic direction over the past year. It appears to be focusing much more on the top line by reducing pricing, increasing support in contracts and pushing its 5% rewards card to all items. To date, that has not resulted in measurable top-line improvement but it has created measurable margin contraction. It may be a necessary move to be competitive with Amazon.com and other online players, but this quarter showed the steepest decline in both retail and contract margins. Indications on the call are that further pricing reductions are ahead, which will keep pressure on margins.

Two items that will keep Staples as an interesting company at this stage are the benefits that should accrue from the merger and evidence internationally that the expense savings are accelerating. The hope is that market share gains, as consumers appreciate the pricing and service moves, lead to improving comps, which in turn arrests the margin deterioration.

Weak margins for Advance Auto Parts

Similarly, Advance Auto Parts (NYSE: AAP) is viewed as the poor house in a very rich do-it-yourself auto neighborhood. That analogy reflects weaker comp and margin results over the last few years. In its recent conference call, the company laid out its investments and strategy to close the gap and more importantly, to significantly improve the company’s commitment to commercial customers. Some of these have been overdue and the Street applauds management's willingness to make the investments even in a sluggish top-line environment. These investments should drive stronger sales as customer inquiries will be filled more often; however, there might not be any material impact in the near term.

An under-performer worth a look

PetSmart (NASDAQ: PETM), perhaps, has had the least capital appreciation among the four companies expected raise their dividends. However, the reason for that has been the attention this space gets from Amazon. While one shouldn’t discount a threat from a company whose ROI is evaluated more leniently by the Street, investors underestimate the importance of PetSmart and the other specialty pet superstores to suppliers.

It makes little sense for those suppliers to undermine their own pricing and support structure for market share. Iams tried this 13 years ago when it expanded its distribution to mass channels, and that brand lost its cachet and has never recovered. Hence, while the Internet will remain a threat, this might not be a reason to ignore one of the best-positioned and highest-quality growth stories in the space.

Final word

With the 10- year Treasury yield at 2.3%, dividends represent an increasingly attractive way to generate investment return. Along with this, the retailers have got the example of Williams-Sonoma’s rally after a dividend hike. There are a number of retailers that have the capacity to significantly increase their dividend payments, which provides an additional catalyst to own these names. Bed, Bath & Beyond, Staples, Advanced Auto and PetSmart are the top four choices.

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.


Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends PetSmart. The Motley Fool owns shares of Staples. 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!

blog comments powered by Disqus