4 high-growth dividend champions

Over the last few months I’ve mostly written about high yield stocks and the occasional high-profile disaster. That sort of thing isn’t to everyone’s taste, so this month I’ll be looking at something completely different. More specifically, I’ll be looking at four high growth “dividend champions”, companies that have grown quickly whilst raising their dividend every year for at least the last decade or so. The high growth requirement adds a bit of spice and makes this list a little different from most dividend champion lists, as those tend to focus on large stalwarts such as Unilever and Shell.

This list, on the other hand, starts off with a couple of very high growth, market-leading internet stocks:

Moneysupermarket.com Group PLC

• Index: FTSE 250
• Share price: 287p
• 10Yr Growth rate: 23%
• Dividend yield: 3.6%

Moneysupermarket.com (LON:MONY) is the UK’s leading comparison website. It enables millions of people to compare prices on car insurance, home insurance, energy providers, credit cards and more. And what a success it has been, with a ten-year growth rate of 23% and a dividend that has tripled over that period.

The dividend yield is surprisingly high for a company with such a high historic growth rate, although as you might expect, its growth has gradually slowed as the company became ever larger. Last year for example, the dividend grew by “just” 6%, although that’s still pretty good for a company with a near-4% yield.

On the plus side the company has no debt and, as an internet business, it doesn’t need to invest heavily in plant and machinery which gives it a somewhat low capex to profit ratio of 40% (most companies fall into the 50% to 100% range). Average return on capital employed is also good at just over 15% and the company has a 100% track record of increasing revenues, profits and dividends over the last decade.

Don’t miss John’s next piece in the next edition of Master Investor Magazine – Sign-up HERE for FREE

That’s the good news. The bad news is that the price relative to the company’s ten-year average earnings (the PE10 ratio) is a bit on the high side. To be honest this is what I’d expect to see given the company’s high growth rate. Still, at 37 the PE10 ratio is above my usual cut-off point of 30.

However, that ratio could be misleading. After all, the dividend yield is almost 4% which suggests the shares are not expensive. Also, the PD10 ratio (price to ten-year average dividend) is only 40, some way short of my cut-off point for that ratio of 60.

With a PE10 ratio of 37 and a PD10 ratio of 40, it’s clear that the company’s earnings aren’t much higher than its dividend. In fact, Moneysupermarket.com’s dividend cover has averaged just 1.1 over the last decade, largely because (I suspect) it has little need for all the cash it throws off, so it sends the cash to investors instead. And that’s why the high PE10 ratio might not be a problem.

In summary then, this is a company I’d like to look at more closely, especially if the share price dropped by another 20% to 220p or less. At that price the valuation ratios would be acceptable to me and I might be willing to buy (assuming no unforeseen skeletons in the closet).

Rightmove PLC

• Index: FTSE 250
• Share price: 4,193p
• 10Yr Growth rate: 22%
• Dividend yield: 1.4%

Second on this list of high growth dividend champions is Rightmove (LON:RMV), the UK’s leading property portal. Like Moneysupermarket.com, Rightmove is an internet business with a ten-year growth rate of more than 20% (22% to be precise). Rightmove has achieved this impressive rate of growth primarily because it’s the eBay of UK property. And that’s a good thing because both eBay and Rightmove benefit enormously from something known as the network effect.

The network effect is an extremely powerful competitive advantage; a virtuous circle that can quickly lead to total market domination. For Rightmove it works like this: Rightmove has the largest inventory of UK property for sale or rent listed on its website. This makes it attractive to people who want to buy or rent, and that’s why its website attracts more people interested in buying or renting property than any other UK website. And because it attracts the largest number of buyers and renters it’s a very attractive place to advertise property for sale or rent. And that’s why it has the largest inventory of UK property on its website. And on and on the virtuous circle goes.

This positive feedback loop is almost impossible to break, which makes Rightmove a very attractive proposition, at the right price of course.

For more insight and analysis like this, CLICK HERE to read Master Investor Magazine for FREE.

As with Moneysupermarket.com, Rightmove has no debt and an extremely low capex ratio of just 2%. In other words, it has almost no capital assets whatsoever and therefore almost no need for capital expenses. This lack of capital assets shows up in the company’s completely ridiculous return on capital employed ratio, which has averaged more than 800% over the last decade. The downside is that the company invests very little into capital assets, but when it does it gets an 800% annual return.

As you might expect with such a dominant high growth company, the share price is high and the dividend yield is low. Having said that, the latest dividend increase was 14%, so a sub-2% yield might still be enough to produce high returns for investors, as long as that kind of growth rate can be sustained. Personally though, I think the price is too high. Yes, Rightmove is likely to continue to dominate its market and may well have many more years of growth ahead of it, but then again, it might not. And with PE10 and PD10 ratios of 52 and 138, it’s far too expensive for me.

As for what the right price might be, something like 2,000p or less would spark my interest. That’s a big drop from its current share price, but in the stock market surprising things happen all the time.

Diploma PLC

• Index: FTSE 250
• Share price: 1,068p
• 10Yr Growth rate: 14%
• Dividend yield: 2.1%

Diploma’s (LON:DPLM) revenues are split fairly evenly across three businesses: Life sciences, Seals and Controls. The Life Sciences business supplies diagnostic instruments, surgical devices and other related products and services to the healthcare industry. The Seals business supplies seals, filters and other products to the heavy mobile machinery market (think JCB diggers) and the general industrial market. The Controls business supplies wiring and fasteners as well as temperature, pressure and fluid control systems to various markets including aerospace, motorsport and catering.

Diploma has been very successful over a long period of time and, like the two companies above, it has a 100% track record of revenue, earnings and dividend growth over the last decade. Also, like Rightmove and Moneysupermarket.com, Diploma has almost no debt.

Somewhat surprisingly for an engineering company, Diploma has relatively low capital expenses. That strikes me as odd since the company has factories, machinery and other capital assets which are required to run a manufacturing business. But the numbers don’t seem to lie; the company has £23 million of tangible capital assets which require about £3-£4 million of capital investment each year for replacement and expansion. That may sound like a lot, but it isn’t compared to the company’s post tax profits, which have averaged around £50 million over the last few years.

Don’t miss John’s next piece in the next edition of Master Investor Magazine – Sign-up HERE for FREE

However, Diploma also has almost £180 million of intangible assets on its balance sheet, an amount which dwarfs its £23 million of tangible assets. These intangible assets are mostly goodwill from acquisitions. I’m not a fan of acquisitions, but some companies are able to turn acquiring and developing companies into a core competence, and Diploma may be one of those. The acquire, build and grow model is a key part of the company’s strategy and it runs these acquired companies as independent operations, aided and supported by both the “head office” business and rest of its subsidiary network. What I like most about Diploma’s acquisition strategy is that it has been carried out almost entirely without the use of borrowed money, which suggests to me that these acquisitions really are well thought out, rather than just a desperate attempt buy growth rather than build it.

The main downside once again is price, although this time the price is almost right, at least for me. At 1,068p the company has a dividend yield of 2.1%, which isn’t bad for a double-digit growth company. It also has PE10 and PD10 ratios of 35 and 70 respectively, which are only just above my upper limits of 30 and 60 respectively.

For me to be happy with Diploma’s price, it would have to drop below 900p, which is a pretty small decline in the big scheme of things. Of course, I would have to look at the company in more detail first; but following this quick overview Diploma looks like a company I’d be happy to invest in at the right price.

Dunelm Group PLC

• Index: FTSE 250
• Share price: 549p
• 10Yr Growth rate: 13%
• Dividend yield: 4.7%

Dunelm (LON:DNLM) is the UK’s leading homewares retailer, selling curtains, cushions and other home furnishings through its network of over 160 out-of-town superstores, as well an increasingly important website.

Unlike the previous three companies, Dunelm misses out on a 100% track record of revenue, earnings and dividend growth over the last decade. Instead it scores a still very impressive 96%, only let down by a small decline in normalised EPS in 2017. As you might expect, the market is not happy with declining earnings so another difference between Dunelm and the other companies is that it has low valuation multiples and a market-beating dividend yield.

As well as these differences, there are similarities. Dunelm uses some debt, but less than most companies. Its borrowings are just 1.5-times recent average profits and by my estimations that’s a very prudent policy (the average debt-to-profit ratio on my stock screen is 4). It also has relatively little need for capital expenses, with capex averaging just 46% of profits over the last decade. That’s less than the market average capex to profit ratio, which is about 66%. Excessively large acquisitions are not a problem either and the dividend has typically been covered about twice over by free cash flows.

At first glance then, Dunelm looks like a company I’d be happy to invest in, except this time the price is attractively low as well. Unfortunately though, Mr Market doesn’t offer low prices for no reason. There are almost always problems associated with low valuation multiples and high yields, and Dunelm is no exception.

For more insight and analysis like this, CLICK HERE to read Master Investor Magazine for FREE.

In this case there are three main problems as I see it: Brexit, stalled like-for-like growth and a slower store rollout programme. Brexit is an obvious uncertainty for UK-focused retailers, even though we don’t yet know for sure whether the long-term impact will be good or bad. Either way, uncertainty is a risk and Mr Market demands a higher potential return from higher risk investments, and in this case that means a lower share price and a higher dividend yield. As for like-for-like growth, it has barely kept up with inflation over the last few years and actually declined in 2017, so this doesn’t look like a source of attractive growth for the company. That leaves new store openings as the main growth driver, but even there the news is not good.

New openings have fallen from around 10 per year for most of the last decade to an average of six per year over the last two years. As the total number of stores increases, that lower number of new stores looks even worse as a percentage of the total. For example, annual new store openings have fallen from about 12% of total stores a few years ago to just 4% or so today.

This combination of weak like-for-like growth and slower new store openings has decreased the company’s “expected” annual growth rate (equal to like-for-like growth plus new store growth) from more than 10% in recent years to just 5% in the last couple of years. 5% is still a reasonable growth rate, but if investors are to get a decent return then a high yield will be required to make up the difference, and that’s largely why Dunelm’s yield is around 5%.

Nobody can know whether Dunelm will thrive or stagnate, but of these four high growth dividend champions Dunelm is the only one I’m currently invested in. However, at first glance the other three also look like companies I’d be happy to own, but only if the price contains a reasonable margin of safety.