Dividend growth stocks can be among the best-performing stocks over the long term, and the "Dividend Aristocrats" are a great place to look for high-quality dividend growth stocks.
The Dividend Aristocrats are a group of 53 stocks in the S&P 500 Index, that have raised their dividends for 25+ consecutive years. The Dividend Aristocrats generated annual returns of 13.6% in the past 10 years, compared with total returns of 12.0% for the broader S&P 500 Index in the same period.
Cardinal Health (CAH) is a Dividend Aristocrat, as it has increased its dividend each year for more than 30 consecutive years. Cardinal Health shares have declined 15% this year, due to difficult operating conditions for the pharmaceutical distribution industry. But the company is a market leader in an industry that still has long-term growth potential.
Cardinal Health stock is undervalued, and with an attractive 3.7% dividend yield, it is the top Dividend Aristocrat stock to buy today.
Business Overview and Current Events
Cardinal Health operates in the healthcare sector. It distributes pharmaceutical and medical products in the United States. The current environment has become more difficult for distributors like Cardinal Health in the past year, due primarily to falling drug prices. This has weakened margins, which has reduced profits for Cardinal Health and others.
However, investors with a long-term focus have reason to like Cardinal Health. That is because the fundamentals of the healthcare industry remain attractive for investment. Specifically, the aging population in the United States is a long-term driver of growth for the healthcare industry. According to the U.S. Census Bureau, by 2035 there will be 78 million people 65 years of age and older, compared with 76.7 million under the age of 18. If estimates prove accurate, by 2035 adults 65 and over will outnumber children for the first time ever. At the same time, U.S. healthcare spending is expected to increase 5.3% in 2018—a higher rate than GDP growth.
All this means demand for healthcare products that Cardinal Health distributes, should only see rising demand going forward. Cardinal Health’s profits are down now, due to weak healthcare pricing. For example, Cardinal Health’s adjusted earnings declined 23% in the most recent quarter, and by 7% in the recently-completed fiscal year.
But this should only be a short-term trend. Cardinal Health is expected to grow earnings-per-share by 9% over the next five years. In the meantime, the stock is deeply undervalued compared with its long-term growth potential.
High Expected Returns for This Dividend Aristocrat
Cardinal Health should return to earnings growth over the next few years, because it retains a leadership position in the industry. It is one of the three major healthcare product distributors in the United States, with a vast customer network. The company serves over 24,000 pharmacies and more than 85% of hospitals. The drop in pharmaceutical prices could only be temporary, given the aging population and high growth rate of healthcare spending.
Cardinal Health is expected to generate adjusted earnings-per-share of $5.03 in 2019. This means the stock currently trades for a price-to-earnings ratio of 10.3, which is a low valuation multiple for a highly profitable company with durable competitive advantages. A reasonable estimate of fair value for Cardinal Health stock would be a price-to-earnings ratio of 15-16. As a result, a rising valuation multiple could add roughly 8.5% to shareholder returns.
In addition, Cardinal Health will generate returns from earnings growth and dividends. Assuming 9% earnings growth, plus the 3.7% dividend yield, means Cardinal Health’s expected returns exceed 21% per year over the next five years.
Cardinal Health should continue its dividend growth streak for many years. The company had a dividend payout ratio of 38.2% in fiscal 2018. This is a fairly low payout ratio, which means Cardinal Health’s earnings easily cover the dividend. There is plenty of room for future dividend increases. Cardinal Health should remain a Dividend Aristocrat for the foreseeable future. The recent downturn in the share price is simply a fantastic buying opportunity for dividend growth investors.
(Disclosure: I am long CAH)
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