Dividend Growth Potential From Low Payout Ratios

Many professional analysts, traders and private investors use the payout ratio metric to determine a company’s ability to continue paying dividends and its ability to increase dividends. Lately I have heard a lot of talk about how low current payout ratios are compared to historical averages and that we should take this as a sign that companies will soon be boosting dividends to get back in line with their historical numbers. The idea is that companies have not been increasing dividend distributions in an effort to hoard cash during the difficult downturn in the economy.

A quick note on payout ratios:
A payout ratio is the percentage of earnings a company returns to its shareholders in the form of a dividend. I typically like to see payout ratios under 65% so that I know the company is keeping at least 35% of its profits to expand and grow its business. You can learn more about payout ratios here.

Finding Undervalued Dividend Stocks

The idea being floated in the general investment community is that solid stocks with below average payout ratios stand to go higher when they start to increase the company distributions back to normal levels. The challenge is to identify solid dividend-paying stocks with below average payout ratios. I used the following four lists of dividend stocks to develop a wide base of high quality investment options: The Dow 30, The Dividend Aristocrats, The Vanguard Dividend Growth Fund and the S&P 500 High Quality Portfolio (SPHQ). This represents over 200 stocks with dividends. I excluded REITs and companies that had little or no dividend history.

This was a fun project because it was very interesting to see how payout ratios fluctuated over the last 10 years. Most companies had a hard time keeping payout ratios low during the great recession and you can see a big jump higher during 2008 and 2009. I wanted to account for that large shift so in addition to finding the 10 year payout ratio average I also determined payout ratio averages for Prerecession (2003 – 2006), Post-Recession (2010 – 2012).

Which Dividend-Paying Stocks

I used the following indexes, funds and lists to create the base list of stocks. You can click on each one to see the full 10 year history for each of the lists.
Dow Jones Industrial Average
Dividend Aristocrats
The Vanguard Dividend Growth Fund
S&P 500 High Quality Portfolio (SPHQ)

The Results Are In

This could be a great way to find companies that are likely to boost its dividend. Dividend increases have always been a key driver for higher stock prices and total return to investors. Identifying companies that have lower than average payout ratios could be a sign that the company will soon increase its dividend and send the stock price higher. Its important to note that a low payout ratio all by itself is not a sign of future growth. Some companies have a history of keeping them low. It is more important to look at what the company has traditional done for its shareholders.

Below you’ll find the lists of stocks that had the greatest difference between their current payout ratio and average payout ratio in for each date range.

10 Year Average

Top 15 stocks with current payout ratios under their payout ratio average from 2003 – 2012:

NameSymbolYield10 Year
Payout Ratio
Payout Ratio
Merck and CoMRK3.7234.984.5177.90%
Marsh & McLennanMMC2.4105.142.3148.40%
HCP IncHCP4245.9109.3124.90%
Wells Fargo & Co.WFC2.748.423.2108.80%
Snap-On IncSNA1.848.226.979.20%
Leggett & PlattLEG3.410067.947.30%
PNC FinancialPNC2.741.229.340.50%
PPG IndusPPG1.753.238.637.80%
Pfizer Inc.PFE3.193.169.833.40%
Illinois Tool WorksITW2.434.128.121.40%
Consolidated EdisonED475.762.720.70%
VF CorpVFC237.131.218.80%
Deere & CoDE2.427.32318.70%
Campbell Soup CoCPB2.54437.318.0%

Pre Recession 2003 – 2006

Top 15 stocks with current payout ratios under their payout ratio average from 2003 – 2006:

NameSymbolYieldPre Recession
Payout Ratio
2003 - 2006
Payout Ratio
Marsh & McLennanMMC2.4126.342.3198.60%
JPMorgan ChaseJPM3.151.323.1122.30%
Wells Fargo & Co.WFC2.743.623.287.90%
HCP IncHCP4190.3109.374.10%
Merck and CoMRK3.7136.184.561.00%
Pfizer Inc.PFE3.111269.860.40%
PNC FinancialPNC2.742.329.344.50%
Consolidated EdisonED486.762.738.20%
Raytheon CompanyRTN3.847.235.433.30%
Chevron CorpCVX332.226.421.90%
Baxter InternationalBAX2.543.237.614.90%
Du Pont (E.I.) De NemoursDD3.573.665.113.10%
Genuine PartsGPC2.752.647.810.00%

Post Recession 2010 – 2012

Top 15 stocks with current payout ratios under their payout ratio average from 2010 – 2012:

NameSymbolYieldPost Recession
Payout Ratio
2010 - 2012
Payout Ratio
JPMorgan ChaseJPM3.155.623.1140.70%
Nucor CorpNUE3.3165.192.678.30%
Cincinnati FinancialCINF3.396.46353.00%
Paychex IncPAYX3.788.662.142.70%
HCP IncHCP4153.1109.340.10%
Marsh & McLennanMMC2.457.742.336.30%
Leggett & PlattLEG3.488.467.930.10%
Campbell Soup CoCPB2.546.637.324.90%
Illinois Tool WorksITW2.435.128.124.90%
Clorox CompanyCLX2.970.758.221.50%
VF CorpVFC236.931.218.40%
Honeywell InternationalHON2.248.841.417.90%
Cardinal Health IncCAH2.834.129.216.90%

There you have it. I was disappointed that I did not find more stocks with a great difference between average and current payout ratios. There are plenty of other stocks that didn’t make the top 15 of each list but the difference in ratios is only about 10% or less. I personally don’t think I’d invest in a stock with a payout ratio of 40% just because its average is 44% or 42% normally.

What this really tells me is that there may be companies out there that have lower payout ratios but very few of those fall into the solid categories I traditionally like to invest in like the best dividend list.


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