Investors are doing their best to identify the most promising stocks, which will help them achieve their financial goals. A key criterion for the selection of the most promising stocks is the growth of earnings per share. All else being equal, the faster a company grows its EPS the greater the upside potential of the stock.
In fact, earnings growth is the primary reason behind the vast outperformance of stocks versus bonds in the long run.
Let’s review the prospects of three dividend-paying stocks likely to grow their earnings at double-digit rates over the next five years.
Tasty Earnings: Yum Brands
Yum Brands (YUM) owns the KFC, Pizza Hut, Taco Bell and The Habit Restaurants chains. It is in more than 155 countries and has more than 54,000 restaurants, 60% of which are located abroad. KFC generates approximately half of the total revenue and operating profit of the company.
Yum Brands completed a major transformation project in 2019. It spun off its Chinese segment to get rid of the impact of the volatile business performance of this segment on its overall performance. In addition, the company refranchised its stores at a fast pace, from 77% in 2016 to 98%. Moreover, Yum Brands used the proceeds from the sale of its stores to franchisees to repurchase its shares aggressively. Thanks to the refranchising, Yum Brands has become more efficient, with much lower operating expenses and a wider operating margin. It is thus able to handle more leverage.
Yum Brands has outperformed its peers in business performance by a wide margin throughout the pandemic thanks to its quick adjustment to an off-premise environment. Despite the unprecedented lockdowns in 2020, the company grew its earnings per share by 2% in that year, whereas McDonald’s (MCD) and Restaurant Brands International (QSR) incurred an approximate 20% decrease in their earnings per share.
Moreover, Yum Brands has an exceptionally consistent growth record. To be sure, the company has grown its earnings per share in eight of the last nine years, at a 4.8% average annual rate. During the last five years, Yum Brands has grown its earnings per share at an 8.8% average annual rate. Even better, the restaurant chain still has ample room for future growth thanks to the opening of many new stores and high growth of same-store sales. Management has provided guidance for 4%-5% average annual growth of the store count in the upcoming years. Given all these factors and its strong business momentum, Yum Brands can be reasonably expected to grow its earnings per share by about 10% per year on average over the next five years.
Yum Brands is offering a 1.8% dividend yield, which is lackluster for income-oriented investors. However, Yum Brands has grown its dividend by 10.3% per year on average over the last decade and by 13.7% per year on average over the last five years. Thanks to its promising growth prospects and a healthy payout ratio of 49%, the company is likely to continue raising its dividend meaningfully for many more years.
Market Insurance: Cigna
Cigna (CI) is a leading provider of insurance products and services. Its products include dental, medical, disability and life insurance, which are provided through employer-sponsored, government-sponsored and individual coverage plans. Cigna operates four business segments, including Evernorth, which provides pharmacy services and benefit management, U.S. Medical, which provides commercial and government health insurance, International Markets and Group Disability. Evernorth generates 70% of total revenues while Cigna Healthcare generates 24% of total revenues.
Cigna has some significant competitive advantages. It is one of the largest players in its industry and hence it enjoys economies of scale and efficiencies that its competitors cannot match. More importantly, an aging demographic will need increased pharmacy and medical services in the upcoming years, thus offering a significant growth driver to the insurer.
Another major growth driver has been the acquisition of Express Scripts by Cigna in 2018. This acquisition, which has greatly strengthened the presence of Cigna in its pharmacy business, has fueled growth in recent years. Since 2018, Cigna has grown its earnings per share every year, at an average annual rate of 13.1%. The company also has an exceptional growth record. It has grown its earnings per share in eight of the last nine years, at an average annual rate of 14.7%.
Moreover, Cigna does not rest on its laurels. It aims to reduce its health care costs, which have risen faster than inflation. Given the reliable business model of Cigna and its consistent growth record, we expect it to grow its earnings per share by 10% per year on average over the next five years.
Notably, the dividend has never been a priority for Cigna. After cutting its dividend by 20% in the Great Recession, in 2009, the company paid the same (negligible) dividend every year until 2020. Cigna typically paid an annual dividend in April of each year. The company changed its policy in the first quarter of 2021, when it declared a quarterly dividend of $1. Moreover, Cigna raised its dividend by 12% in 2022 and by 10% in the beginning of this year. As a result, the stock is currently offering a 1.7% dividend yield, with a solid payout ratio of 20%. Nevertheless, Cigna is attractive for its promising growth prospects, not for its dividend.
The Right Direction: Garmin
Garmin (GRMN) is a technology company based in Switzerland. It manufactures navigation, communication and information devices and applications, which are enabled by GPS. Its business segments are the following: auto, aviation, marine, outdoor, and fitness. The auto segment offers auto navigation products for vehicles. The aviation segment includes navigation, communications transmitters and receivers, multi-function displays, electronic flight instrumentation systems, automatic flight control systems and traffic advisory systems. The marine segment includes products for recreational boats. The Outdoor segment includes products for outdoor activities, while the fitness segment makes products that track activity.
Garmin became well-known primarily thanks to its automotive GPS devices. However, GPS devices for the automotive industry have been rendered virtually obsolete due to the widespread adoption of the smartphone. This was a strong headwind for the company in the beginning.
Fortunately, Garmin invested heavily in non-automotive markets in order to fuel future growth. Thanks to its successful turnaround, the company has become a leader in aviation and marine products. Overall, it has exhibited a strong performance record. It has incurred a meaningful decrease in its earnings per share only once in the last nine years and has grown its bottom line at an 8.6% average annual rate over this period.
Garmin lacks a meaningful competitive advantage due to the intense competition that is prominent in technology products. Nevertheless, thanks to its expertise and the existence of ample room for future growth, the company is likely to continue growing its earnings per share at a nearly double-digit rate over the next five years.
Garmin froze its dividend during 2015-2017 and hence it does not possess a long dividend growth record. It is currently offering a 3.0% dividend yield, with a decent payout ratio of 59%. Overall, the dividend is not a top priority for Garmin but this has proved positive for the shareholders, as the investments in growth endeavors have undoubtedly born fruit.
Stocks have outperformed bonds by an impressive margin for decades. The key behind this vast outperformance is the growth of earnings of many stocks. Therefore, investors should do their best to identify companies that are likely to grow their earnings at a fast pace.
Yum Brands, Cigna and Garmin have admirable growth records and are likely to continue growing their earnings at a fast pace for many more years. Given also their reasonable valuation levels, these stocks are likely to highly reward their shareholders.