With inflation rising to 1.6%, dividends are being squeezed in real terms. Therefore, the potential for a high yield may gradually become more significant to income investors than a high yield today. In other words, a company with fast-growing dividends may become more popular than a company unable to beat inflation when it comes to shareholder payouts.
With that in mind, here are two companies that have the potential to raise dividends at a rapid rate to become high-yielding stocks in the long run.
An improving banking play
Although HSBC (LSE: HSBA) yields a relatively high 5.9% at the present time, its yield could increase significantly over the medium term. A key reason for this is its strategy, which seeks to reduce its cost base and generate significant efficiencies in future years. This is set to boost the bank’s bottom line in the current year and next year, with it forecast to return to profit growth following three consecutive years of a falling bottom line.
Growth in earnings of 6% is expected this year, with 7% forecast in 2018. This will mean that the bank’s payout ratio stands at 73% next year, which indicates that dividends could rise at a faster pace than profit. HSBC’s exposure to the rapidly growing Asian economy could mean its profitability rises rapidly, since demand for credit is likely to soar as a more consumer-focused society begins to emerge.
Therefore, despite being one of the highest-yielding FTSE 100 companies around, a more obvious reason to buy HSBC is its potential to deliver higher dividends in future years. And with a price-to-earnings growth (PEG) ratio of 1.8, it seems to be favourably priced too.
A consistent performer
In the last five years, support services company Compass (LSE: CPG) has recorded a rise in its bottom line of 9.3%. Looking ahead to the next two years, further growth of 12.4% per annum is currently forecast. This could enable the company to grow its shareholder payouts by a similar amount – especially since dividends are covered almost twice by profit. This could mean that the company’s yield of 2.4% becomes increasingly enticing over the medium term.
Of course, a yield of 2.4% is less than the FTSE 100’s yield of around 3.6%. However, the reality is that Compass is likely to raise dividends at a double-digit rate over the medium term and should therefore provide a higher income return in the long run than the wider index. In addition to this, the company has a PEG ratio of 1.2, which indicates that a substantial upward re-rating could be on the horizon. As such, its total returns could be ahead of the wider index.
Compass also offers a less volatile shareholder experience than the FTSE 100. For example, it has a beta of 0.6. Given the risk posed by Brexit to the UK economy, reduced volatility could be a useful ally during the course of 2017 and beyond.
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Peter Stephens owns shares of HSBC Holdings. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.