Dividend growth rates are often overlooked by investors. Income investors are usually more concerned about dividend yields, while growth investors tend to focus on earnings performance. However, dividend growth can offer an insight into management’s confidence in the company’s outlook, as well as its financial position.
With that in mind, here are two FTSE 100 stocks which have strong dividend growth potential. Over the medium term, they could generate impressive income and capital returns for their investors.
Reporting on Wednesday was diversified industrials company Smiths Group (LSE: SMIN). It has been able to return to revenue growth in the 11 months to 30 June 2018, with its top line rising by 3% on an underlying basis. It has experienced positive growth from a number of its divisions, although its Medical segment has experienced a challenging period.
The Medical unit has seen a temporary suspension of the sale of some of its products in Europe. This is in advance of a new EU Medical Device Regulation that is due to come into effect from 2020. As a result of this, the Medical division is expected to report a 2% fall in revenue for the full year. However, excluding these one-off disruptions, the underlying performance of the division has been positive.
Looking ahead, Smiths Group appears to have strong dividend growth potential. Its bottom line is due to rise by 12% next year, and with it having a dividend coverage ratio of 2.1, it could afford to pay a higher proportion of earnings as a dividend. Following Wednesday’s update, its shares declined by around 8% due to the news concerning its Medical division. But as they are now trading on a price-to-earnings growth (PEG) ratio of 1.5, they seem to offer excellent value for money.
Also offering impressive dividend growth potential is support services company Compass Group (LSE: CPG). It has a solid track record of dividend hikes, with shareholder payouts rising at an annualised rate of 8.7% during the last four years. With dividends currently covered 2.1 times by profit, there seems to be scope for further fast-paced payout growth over the long run.
Compass is a relatively stable stock. Its sales and profit performance have been robust even during periods of difficulty for the wider economy. As such, it could be a sound defensive stock to hold in case of economic difficulties in both the UK and internationally. And since it has global exposure, it could provide a relatively low-risk investment opportunity for the long run.
With the stock forecast to post a rise in earnings of 6% this year and 8% in the following year, its outlook is upbeat. With a solid growth strategy and a strong balance sheet, Compass Group could offer an appealing risk/reward ratio given the uncertain outlook for the UK economy.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has recommended Compass Group. 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.