First-quarter earnings season has revealed a very big problem for the S&P 500.
With weakness in China and Europe weighing on the global economy, sales growth continues to slow.
That’s always a concern for investors, but after four years of extreme cost cutting that has pushed margins to record highs, limited sales growth is a huge headwind for earnings growth.[ad#Google Adsense 336×280-IA]And there is nothing more important to gains on the chart than earnings growth.
But here’s the good news: The S&P 500 has never been better equipped to combat this problem.
With the private sector sitting on record margins and earnings, cash and short-term investments have grown to record levels, up 6.1% in 2012 to $1.27 trillion.
And that is how the S&P 500 is going to counter slower sales and earnings growth and incentivize investors: by using its record cash balance to fuel dividend growth.
In fact, this is already happening. According to data from FactSet Research Systems (NYSE: FDS), as of March, dividend growth in the S&P 500 is up 17% from last year.
That rate is more than twice the long-term growth average of just 6%.
In a great example of this trend, Apple (Nasdaq: AAPL) is now yielding 2.9% after shares fell from above $700 last year to $425. Apple has been working to grow sales and earnings, but it turns to its record cash balance of more than $100 billion to retain its current shareholders and attract a new class of investors searching for income.
This bullish trend in the dividend growth rate has the S&P 500 carrying an outsize 2.1% dividend yield, well ahead of the 10-year Treasury note’s yield of just 1.7%.
As you can see, the S&P 500 isn’t content to let slower sales growth get in the way of producing gains for investors, making this a great time to invest in companies with strong cash balances and a history of outsize dividend growth. This is the strategy behind Street Authority‘s “Dividend Vault,” a portfolio of U.S. companies sitting on a $1.7 trillion cash pile that could be rewarded to investors.
These are the nine S&P 500 companies that have logged the biggest dividend growth in the past five years.
From this group, I’m highlighting Wynn Resorts (Nasdaq: WYNN) because of its large dividend yield and bullish growth projection, and Ensco (NYSE: ESV) because of record-low valuation.
Wynn Resorts has grown its dividend an aggressive 142% in the past five years, to an outsize 3%. But the casino and resorts owner and operator isn’t just an income play — the company continues to see big gains in sales and earnings. Analysts forecast 23% earnings growth in this year and 12% annual growth in the next five years.
In spite of an impressive 16% gain in its most recent fiscal year, Wynn’s shares trade with a forward price-to-earnings (P/E) ratio of 20, just a 15% premium to the industry average.
Ensco has grown its dividend 123% in the past five years, lifting its dividend yield to 3.6%. With natural gas and oil prices moving higher in 2013, analysts are expecting big results from Ensco this year, projecting earnings growth of 23%.
In the next five years, analysts are calling for earnings growth of 25%, well ahead of the industry average of 15%. Despite these bullish growth projections, Ensco’s forward P/E ratio of 8 is a huge discount to the industry average of 46 and the S&P 500’s 14.
Risks to Consider: In the past few years, dividend stocks have experienced outsize gains that have lifted shares to record highs and compressed yields. Rotations into higher yielding stocks could put downward pressure on dividend stocks.
Action to Take –> With the S&P 500 sitting on record cash and struggling to find ways to grow revenue and earnings, many companies are choosing to reward investors directly through dividend growth. These nine companies are great candidates for investors searching for income growth. From the group, I like Wynn Resorts (WYNN) because of its large dividend yield and bullish growth projection, and Ensco (ESV) for its record-low valuation.
– Michael Vodicka
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