The term ‘dividend aristocrats‘ is used to describe companies that have raised their dividends annually for at least 25 years. The label originally applied to US stocks, but some investors also look for UK dividend aristocrats.
Here I explain what the appeal of a dividend aristocrat is to me and examine a couple I would consider buying for my portfolio.
Why UK dividend aristocrats appeal to me
Past dividend performance is not necessarily an indicator of future payouts. Shell, for example, slashed its dividend last year after a 70-year stretch in which it had not cut it at all. Many other previously dividend paying companies also cut, suspended, or cancelled their dividend last year.
Given that, why do I pay special attention to dividend aristocrats? There are two reasons. First, for a company to have been able to raise its dividend regularly over decades suggests that its business model may be resilient and cash generative. Secondly, I think the discipline of raising a dividend annually focusses management’s attention on investor expectations.
Of course, events can change so even a UK dividend aristocrat can find its business model becoming outdated, or new management can adopt a different perspective on dividends. I don’t buy shares just because they are UK dividend aristocrats. But I do use the dividend aristocrat approach as a way of identifying shares that merit further research.
UK dividend aristocrat: Diageo
The first of the two dividend aristocrats I will discuss is better known for its branded products than the company itself. Drinks such as Guinness, Johnnie Walker, and Smirnoff are household names. But the company behind them, Diageo (LSE: DGE), is less famous.
That’s fine because it’s the collection of premium drinks brands that makes the company attractive to me. The branded nature of the portfolio gives the company pricing power. In other words, there is no direct substitute for a brand such as Guinness. So many drinkers who have brand loyalty will likely continue to buy it, even if the company raises the price. That can help to keep the profits rolling in. At a time of rising inflation, pricing power is helpful to maintain profitability. With a post-tax profit last year of £2.8bn, Diageo demonstrates that there is good money to be made in selling alcoholic beverages. That can help to fund a dividend.
The Diageo dividend
Last year, the Diageo dividend was 72.6p per share, which equates to a 2% yield at the current share price. While a 2% yield is attractive to me, it is far from the best on offer among FTSE 100 blue chip shares. Indeed, some tobacco shares offer a yield three or four times higher.
But yield alone is not the only factor to consider when assessing an income share. Last year, for example, the tobacco company Imperial Brands made a swingeing cut to its dividend. While its yield continues to be attractive, it is smaller than it used to be. Imperial had raised its dividend handsomely each year despite its business performing only modestly. A dividend cut thus became all but inevitable.
By contrast, Diageo’s 2% yield may seem fairly small, but it is well-covered by earnings. Last year, for example, basic earnings per share came in at 113.8p. So the dividend was covered 1.6 times from earnings. The company has UK dividend aristocrat status because it has increased its payout each year for 34 successive years. Nor are these increases merely symbolic. Last year, the dividend rose 3.8% from the prior year. That is a significant increase.
Why I’d buy Diageo for my portfolio
One of the things I like about Diageo is that it has both income and growth potential. The dividend offers income potential. But the strong long-term business performance underpinning the dividend also offers growth opportunities. Over the past year, the Diageo share price has increased by a third.
But growth is not assured. One risk for Diageo is an increasing rejection of alcoholic drinks among younger drinkers. There are also growing restrictions on advertising alcoholic beverages in many markets. Both of these trends could hurt revenue and therefore profits at the company. It has responded by expanding its non-alcoholic offering, with drinks such as Seedlip. But the risk remains – and if profits do fall, the dividend may suffer.
Another UK dividend aristocrat: DCC
Just like Diageo, many people haven’t heard of the company DCC (LSE: DCC). Like Diageo, the Irish-based, London-listed company is a UK dividend aristocrat. It has increased its dividend for 27 consecutive years. It also has a recent history of substantial not tokenistic dividend increases. Last year, the payout rose 10%. In fact, this UK dividend aristocrat has seen double-digit dividend increases in four out of the past five years, which certainly grabs my attention as an investor. At the current DCC share price, the company yields 2.6%.
DCC’s business success has been built on its diversification across a number of industries. One of its best-known businesses is gas distribution. It operates a large gas distribution network across much of Europe and the US, under a variety of local brand names. It also has a healthcare business and a technology services offering.
The benefit of this sort of conglomerate approach is that it allows diversification through the economic cycle: if one division underperforms, another business’s strength may compensate for it. But conglomerates themselves come in and out of fashion with investors. Sometimes it can be hard to understand them because of the mix of businesses. I think this may be one reason DCC is still below many investors’ radar, despite its dividend aristocrat status and strong recent growth in payouts.
I’d consider buying DCC to hold
DCC does have risks. For example, environmental regulations could lead to falling gas demand, which could hurt DCC’s profits substantially. Cost inflation also threatens profit margins in the healthcare business if it cannot be passed on to customers in the form of price rises.
But despite the risks, I find DCC’s dividend outlook attractive. I’d consider buying this UK dividend aristocrat, along with Diageo, and holding it in my portfolio for years.
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Christopher Ruane owns shares in Imperial Brands. The Motley Fool UK has recommended Diageo and Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.