Investors often believe they have to choose between income and growth. But the reality isn’t so clear cut.
The two companies I’m looking at today are dividend-paying FTSE 100 firms, but both of them have a strong track record of growth.
Shares of both firms have risen by at least 100% over the last five years, outperforming both the FTSE 100 (+25%) and the FTSE Small Cap index (+78%). Both companies have also delivered substantial dividend growth over the same period.
Recent trading suggests that further gains are possible. The latest broker forecasts predict both firms will deliver earnings per share growth of about 15% in 2017, along with inflation-busting dividend growth.
The Asian growth engine
Insurance group Prudential (LSE: PRU) has a 169-year history here in the UK, but it’s the firm’s Asian operations that are leading its growth, along with a thriving US operation.
During the first half of 2016, Prudential’s group operating profit rose by 6% to £2,059m, adjusted for exchange rate differences. Operating profit from Asia rose by 15% to £743m, highlighting the growing contribution being made by this region.
The opportunity for Prudential is that the insurance market is much less mature in Asia than it is in the West. Rapid growth is possible for companies with effective marketing and competitive products.
Prudential’s operations certainly appear to generate plenty of surplus cash. Net cash remittances from the group’s trading units rose by 5% to £1,118m during the first half of 2016. I estimate that this year’s forecast dividend of 41.6p per share — totalling around £1,073m — should be covered comfortably by full-year remittances.
Prudential currently trades on a 2016 P/E of 13.5, falling to a P/E of 11.6 for 2017. Although the stock’s dividend yield is only about 2.7%, it’s well covered by cash. The Pru’s dividend has grown by an average of 10% per year since 2010, and I believe Prudential could be a buy at current levels.
Will this cash machine ever stop growing?
If Reckitt Benckiser Group (LSE: RB) increases its 2016 dividend by 9.5% as expected, then the consumer goods group won’t have cut its dividend for at least 20 years.
Reckitt’s dividend payout has risen by 479% since 1997. The secret of this firm’s success lies in the very high returns it generates on invested capital. Reckitt’s return on capital employed and its operating margin have both averaged about 25% in recent years.
This helps the group generate high levels of free cash flow, which is used to fund the dividend and further growth. It also means that net debt is very low.
As you’d expect from such a high-quality business, Reckitt shares don’t come cheap. The group’s stock trades on a 2016 forecast P/E of 23, falling to a P/E of 20 for 2017. Dividend yield is 2.2%, rising to 2.5% for 2017.
Quality-focused investors such as Fundsmith’s Terry Smith believe paying a high price for businesses that generate high returns makes sense and leads to long-term out-performance. Mr Smith’s track record suggests he could be right. If you think so too, then Reckitt Benckiser could be an excellent addition to a long-term portfolio.