Buying stocks with high dividend growth potential could be a means of generating high returns over the medium term. Inflation already stands at 2.9% and is forecast to move higher in the coming months. Certainly, an interest rate rise could dampen the upward march of inflation to some extent. However, uncertainty surrounding Brexit could grow and lead to a significant depreciation in the value of the pound.
As such, stocks such as water services company Pennon (LSE: PNN) could be worth a closer look. It has a bright dividend future, but isn’t the only stock which could deliver rising shareholder payouts in the long run.
Improving outlook
Pennon continues to offer a potent outlook of defensive dividend growth. The company’s business model is highly reliable and with lower positive correlation to the wider economy than many of its index peers, it could prove popular among investors should the outlook for the UK economy deteriorate. In such a scenario, investors may seek a ‘flight to safety’ which could include defensive assets such as those in the water services sector.
However, the company is more than just a defensive share. It offers strong dividend growth potential, too. For example, shareholder payouts are expected to rise by 7.2% next year as the company’s profitability is forecast to increase at a double-digit rate. Despite this, the company’s dividends are still due to be covered 1.3 times by profit. This suggests they are highly sustainable and could continue to rise at an inflation-beating rate in the long run.
With Pennon trading on a price-to-earnings (P/E) ratio of 16.6, it appears to have value appeal. Therefore, it could deliver high total returns in the long run following its 12% share price fall in the last year.
Low valuation
Also offering high dividend growth potential is electronic and software specialist Ultra Electronics (LSE: ULE). It reported news of a contract win on Wednesday, with the company being awarded a $16.2m modification to a previously awarded cost-plus-fixed-fee contract by the US Department of the Navy.
Under the terms of the contract, Ultra Electronics will continue to work with the US Department of the Navy to design, develop, integrate and install a variety of cyber-security systems for critical infrastructure control and monitoring. The solutions provide cyber proofing of a number of industrial control systems and electronic security systems in mission critical environments.
Looking ahead, Ultra Electronics is expected to increase its dividend payments by 5% per annum over the next two years. This puts it on a forward dividend yield of 2.9%. With dividends due to be covered 2.7 times by profit next year, there appears to be significant scope for further increases in shareholder payouts. With a price-to-earnings growth (PEG) ratio of just 1.6, the stock looks set to deliver a potent mix of high capital growth and income returns in the long run.
