Often when looking at dividend shares, it can be tempting to zoom in on high yields. Over time, big dividend yields can be very rewarding. I certainly own some high-yielders in my portfolio.
But sometimes, a dividend share attracts me despite a small current payout — because of what I think it might deliver in future.
Focussed business model
An example of this is Judges Scientific (LSE: JDG). If you have never heard of this company, you are not alone. It operates in a niche sector, supplying scientific instruments to customers like universities, commercial labs, and research agencies.
The company management figured out that this industry is highly fragmented. In other words, there are lots of instrument makers that are very small. Some have just a handful of employees, and when the owner retires they may simply wind up the business.
That presents an opportunity for a company like Judges. With limited competition from other bidders, it is able to buy many such small manufacturers at attractive valuations. Focussing on a single area helps to grow Judges’ expertise. So it can help the companies it acquires with things like strategic advice and access to capital. Aside from that, it tends to leave them alone to focus on what they do best.
So far, so good. But what makes this business model attractive from an income perspective?
When it comes to scientific instruments, accuracy and reliability are the name of the game. That means that purchasing decisions tend not to be driven by cost. Instead, customers are looking for a very high level of quality.
That gives a company like Judges pricing power. It can set prices without worrying too much about competition from low-cost producers, for example. By building a reputation for product quality in a specialist area, over time its revenues have grown but not at the cost of attractive profit margins.
Dividend share with growth potential
Last year, the firm made post-tax profits of £13m on revenue of £91m. That sort of profit margin attracts me. As it continues to grow through its acquisitive strategy, I reckon Judges can hopefully keep growing earnings.
At the moment, the dividend yield is only 0.9%. That is low and not especially attractive to me. But what I do like is Judges’ aggressive approach to growing the dividend. Last year saw dividend growth of 20%. The year before was a more modest but still impressive 10%, while before that the payout had increased by 25% for two years in a row.
Past performance is not necessarily indicative of what will come next. But I think Judges’ history of double-digit percentage dividend increases reflects the lucrative nature of its business model. Admittedly, that may not continue. Ongoing pandemic restrictions in some markets may lead to sales being postponed or cancelled. Other companies could copy Judges’ business model, pushing up the purchase price for acquisitions and hurting profit margins.
But so far, Judges has impressed me with its strategy and ability to deliver strong dividend growth. I would consider buying this dividend share for my portfolio not because of its current yield, but the potential for ongoing growth in the payout.