Dividend growth is one of the easiest paths to wealth building. If you buy a high-quality business, hold it for the long term, and watch its dividend per share compound year after year, you can end up with a giant income stream when you retire. All you need is some patience.
For example, since the 1990s PepsiCo‘s dividend per share has grown by 4,480%. This means if you bought the stock at a 1% dividend yield 30 years ago, today you would be getting an annual yield of 45.8% on your cost basis. Not a terrible outcome when all you have to do is buy and hold for the long term.
Two stocks with the potential to greatly increase their dividend payouts are Ally Financial (ALLY) and American Express (AXP). Here’s why now is the time to snap up some shares for your retirement account.
Ally Financial: Mispriced because of the banking crisis
Ally is an online consumer bank that makes loans to car buyers. That means it tries to attract depositors, pay interest on these deposits, and earn more than it pays out by financing car purchases. This is known as the net interest margin (NIM) spread, and it’s the key profit driver for most banking institutions.
The deposit side of Ally’s business has performed well during the past decade-plus. It has increased its customer count for 57 straight quarters, hitting 2.9 million banking depositors in the second quarter of this year. They collectively have $139 billion stored with Ally Bank. A growing deposit base provides Ally with more and more firepower to make auto loans, meaning more profit as long as it is lending to individuals who repay.
Ally’s stock is down at the moment along with most smaller banks amid investor concerns about the potential for another bank failure along the lines of Silicon Valley Bank or First Republic. But this is misguided because unlike some banks that failed, 92% of Ally’s deposits are insured by the Federal Deposit Insurance Corporation and the company actually put up record customer growth during the spring banking panic.
Investors are also worried about underperforming car loans as consumers deplete their pandemic savings. But this is also misguided because of how important cars are to a lot of individuals and families.
With a depressed stock price, Ally trades at a dividend yield of about 4.4% and has increased its dividend per share payout by a whopping 275% since it started paying them in 2018. If the company continues to raise its dividend payout at its historical rate, shareholders who buy today will be headed for an annual yield of more than 10% on their cost basis in no time.
American Express is one of the largest payment networks and credit card issuers in the world. Unlike competitors Visa and Mastercard, American Express has a vertically integrated solution for its merchant customers as it acts as both the payment processor and loan originator for credit cards. Visa and Mastercard only process payments while other financial institutions such as Capital One and Bank of America take the credit risk.
Some investors get concerned that American Express is taking loan risks with its customers, but the company has decades of experience and targets a wealthier clientele with better credit ratings. For example, last quarter only 8% of American Express cardmembers had FICO scores under 660, normally the threshold for subprime loans.
American Express’ dividend is not as attractive as Ally’s, yielding 1.5%, but it should still be able to grow its payout over the long term. From 2024 onwards, management is guiding for American Express to grow its earnings per share at around 15% annually. If these targets are hit, its dividend per share should be able to compound at similar rates.
— Brett Schafer
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Source: The Motley Fool
