Like a lot of investors, I appreciate the passive income streams that can come from owning dividend shares. A number of FTSE 100 shares have excellent track records not just of paying dividends, but of raising them year after year.
British American Tobacco has been doing that since the last century. Diageo has been raising its dividend annually for over 30 years. Meanwhile, Spirax (LSE: SPX) has grown its dividend every year for over half a century.
What I’m looking for now
Past performance is not necessarily a guide to what will happen in future, although I do feel that if business performance allows for it, most boards would be nervous about stopping the sort of long streak of growth in shareholder payouts achieved by these Dividend Aristocrats.
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While I like Spirax’s business and would be happy to own the shares, I have no plans to buy them at the current valuation. The price-to-earnings ratio of 29 is too high for my taste even for such a strongly performing company.
That valuation also means that, even after all those decades of annual dividend raises, the yield is currently 2.1%. That is notably less than the average offered by all FTSE 100 shares, let alone the high-yielding ones.
Still, I think Spirax’s track record can help me when hunting for shares that may possibly deliver a future dividend track record like it has in the past half century – and are reasonably priced now.
Big spending customers with few possible solutions
One clue is in Spirax’s customer base. If you are running a factory and a piece of your machinery suddenly breaks, the potential cost of the delaying stoppage may be huge. In such situations, customers need a solution urgently.
That can mean they are more or less insensitive to price. It can also mean they want to deal with a known quantity in the sense of a firm they have found reliable in the past.
So, Spirax’s focus on industrial customers and its business model of supplying and maintaining often bespoke thermal energy engineering solutions to them is smart, in my view.
Also smart is the fact that the FTSE 100 firm has chosen to operate in areas where competition is limited, giving it even more pricing power. An example is the company’s specialisation in what are known as Watson-Marlow pumps. Thanks to its proprietary technology, Spirax has a unique advantage over competitors.
That said, one risk in such a model is getting greedy. Pricing power is all well and good – but it can motivate rivals to generate innovative solutions at lower cost.
Investors who love dividends love boards that love dividends!
But while having a business that looks set to generate sizeable and increasing free cash flows can help fund regular dividend growth, it is not enough.
After all, lots of companies generate large free cash flows without paying dividends. I also look for a company’s policy to see whether it has what is known as a progressive dividend policy. That means the stated aim is annual growth in dividend per share.
That is a goal and may not ultimately happen. But I see such a policy as a positive signal that a company’s board is focussed on trying to grow its dividend annually.
