The prospect of higher inflation due to a weaker pound means that dividend growth stocks could become more attractive over the medium term. While a high yield may be enticing today, a company which is able to grow shareholder payouts at a rapid rate may better help investors to overcome the threat of higher inflation. And since inflation already stands at 2.6%, such stocks could be worth buying today.
With that in mind, here are two companies which may see their share prices rise due to their dividend growth potential.
Reporting on Monday was diversified food producer and retailer ABF(LSE: ABF). The company has benefitted significantly from a weaker pound during the course of its most recent financial year. Most of its profit is generated outside of the UK, and the prospect of further uncertainty for the UK economy means that it may continue to benefit from currency fluctuations
As well as this, the company's operating performance has also improved. It has been able to grow its Primark retail brand even with the UK economy experiencing consumer weakness. Sales from Primark in the UK were 10% higher, and this shows that a squeeze on consumer spending from higher inflation may push price-conscious shoppers to budget brands such as Primark. The division's operations in the US are also expanding, while its growth potential in Europe remains high.
Alongside Primark's performance was increases in the profitability of all of ABF's other divisions. They provide it with a high degree of diversity and mean that if Primark experiences a difficult quarter, they may be able to offset its performance in the short run.
Although ABF currently has a dividend yield of just 1.3%, its potential to raise shareholder payouts at a rapid rate is high. Its payout ratio stands at just 33% which, for a large and mature company, is relatively low. It could easily afford to pay out twice its current level of dividend and still have sufficient capital to invest in future growth opportunities.
Furthermore, with the company's bottom line due to rise by 18% this year and by a further 10% next year, dividend growth could easily surpass the rate of inflation in the long run. And with a price-to-earnings growth (PEG) ratio of 1.5, it seems to offer value for money too.
With a dividend yield of 6.9%, insurance company Direct Line(LSE: DLG) continues to offer an inflation-beating level of income for its investors. The company also has scope to raise dividends by at least as much as inflation in future years. It currently has a dividend coverage ratio of 1.2, which suggests that dividend growth could match earnings growth over the medium term. With the company's strategy being relatively sound and it having a dominant position within the UK motor insurance sector in particular, its prospects for earnings growth remain bright.
Certainly, there have been challenges within the motor insurance industry in recent years. Notably, there was the change in the Ogden discount rate which was applied to personal injury claims. However, Direct Line seems to have been able to pass this cost on to consumers and remains a strong income stock for the long term.
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Peter Stephens owns shares in Direct Line. The Motley Fool UK has no position in any of the shares mentioned. 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.