While high yields may be the most important aspect of income investing for many investors, the reality is that a fast–growing dividend can have more appeal. That’s because it can allow a company with a modest yield to surpass the income return of a higher yielding stock over the long run. And a fast-growing dividend indicates an improving financial performance by the company in question, or that its management has a high degree of confidence in its future.
One company that offers strong dividend growth is Diageo (LSE: DGE). It may only yield 3.1% at the present time, but its shareholder payouts are covered 1.65 times by profit. This indicates that they could grow at a faster pace than profit in the future and still leave the company with sufficient capital to reinvest for future growth.
Diageo’s exposure to the emerging world is likely to be the factor that transforms its bottom line. As wealth in India and China in particular increases, demand for spirits is likely to rise. Diageo is well-placed in both markets to deliver rising profitability, much of which could be returned to its investors. And with beverages being a relatively stable and consistent place to invest, Diageo appears to be a sound income play for the coming years.
Sound strategy
Similarly, Standard Life (LSE: SL) has ample headroom when making its dividend payments. Its dividends are covered 1.3 times by profit, which shows that payments to shareholders should at least match earnings growth over the medium term.
On the topic of earnings growth, Standard Life is forecast to report a rise in its bottom line of 10% in the current year. This shows that the company’s strategy is working well and when combined with its sound financial standing and the diverse nature of its operations, Standard Life’s risk/reward ratio is relatively appealing.
In addition, Standard Life trades on a price-to-earnings growth (PEG) ratio of just 1.2. This indicates that as well as strong dividend growth prospects, a yield of 5.7% and a strong business model, it has excellent capital growth potential, too.
Meanwhile, Old Mutual (LSE: OML) is forecast to increase its dividends by 16.6% in the 2017 financial year. This puts it on a forward yield of 4% and despite such a rapid rate of growth, Old Mutual’s dividends are still set to be covered 2.7 times by profit. So there’s room for similar rates of growth in the medium-to-long term, even if Old Mutual’s profitability disappoints.
As well as a rapidly growing dividend, it offers upward rerating potential. It trades on a price-to-earnings (P/E) ratio of 10.7, which indicates that it has an appealing risk/reward ratio. Certainly, its past performance indicates that volatility is likely due to the threats of Brexit and a Trump presidency. However, Old Mutual has the financial flexibility to increase dividends and could prove to be a solid income play.