While high yields may grab all of the attention, companies that offer a modest yield but strong dividend growth potential are also highly desirable. That’s simply because there is significant scope for an increasing income which will not only benefit investors’ cash flow, but could also improve market sentiment and push the company’s share price higher.
For example, Tesco (LSE: TSCO) is unlikely to be viewed as a highly appealing income play at the present time. After all, it has a yield of just 0.4% after taking the wise decision to slash its dividend while it undergoes a period of major change. However, in the medium to long term, Tesco could offer a superb pace of dividend growth, since its current payout ratio stands at just 9.5%.
As such, there is considerable scope for Tesco to increase its dividends and, furthermore, it is forecast to post superb earnings growth next year. In fact, Tesco’s bottom line is set to rise by 33% in financial year 2017, which provides it with even greater scope for dividend increases and could improve investor sentiment along the way.
Certainly, Tesco is enduring a highly challenging period and its performance is likely to be volatile. However, with the UK economy continuing to improve and the company having a new management team and refreshed strategy which is focused on streamlining the business and improving efficiencies, Tesco’s financial performance could surprise on the upside and allow it to pay out a far greater proportion of profit as a dividend over the medium to long term.
Similarly, Dixons Carphone (LSE: DC) currently has a yield of just 1.9%, but has excellent earnings growth prospects and a low payout ratio. For example, Dixons Carphone currently pays out just a third of its net profit as a dividend each year, which means that dividends could easily double over the medium term even if there is zero growth in the company’s bottom line. And, with Dixons Carphone set to increase its earnings by as much as 11% next year, it clearly has the scope to vastly improve on its current level of shareholder payouts, with a rapidly growing dividend indicating to the market that the company is performing well and is confident about its long term future.
Meanwhile, storage specialist Big Yellow (LSE: BYG) is a rather rare stock, since it has increased its dividends per share in each of the last four years. In fact they have increased at an annualised rate of 28% during the period and this now means that Big Yellow presently yields 3.5%. And, looking ahead to next year, Big Yellow is forecast to increase dividends per share by a further 12.7%, which puts it on a forward yield of 4%.
That’s despite its share price having soared by 137% in the last five years and, with strong profit and dividend growth set to be delivered over the medium term, Big Yellow could continue to outperform the wider index in future.