Every investor loves dividends, but no investor likes being on the receiving end of a dividend cut, which is usually a painful experience.
I believe that the best way to avoid such a situation is only to buy the market's best dividend growth stocks. Specifically, companies that already support attractive yields but with room for payout growth are, in my view, the best income buys as the chances of a dividend cut are significantly reduced.
Residential landlord Grainger(LSE: GRI) is one such example. Over the past five years, Grainger's dividend per share has increased from 2p to 4.9p, a compound annual growth rate of 19.6%. And there's plenty of room for further payout growth as the dividend is currently covered 2.6 times by earnings per share.
Dividend growth champion
Some investors might be put off by the firm's low dividend yield of only 1.8%, which is around half of the market average. However, if the payout continues to expand at a double-digit percentage every year, it won't take long for the yield to hit a more respectable level.
For example, City analysts have pencilled in a prospective dividend of 5.7p per share for the fiscal year ending 30 September 2018, up 16% year-on-year giving a yield of 2.1% at today's prices. According to my calculations, if the payout grows at this rate for the next five years, it will have risen to 12p by 2023 for a yield of 4.5% at today's prices.
A payout of 12p per share by 2023 is a realistic target as the firm is set to report earnings per share of 12.8p for the current financial year. Assuming management can grow earnings per share at a rate of 5% per annum for the next five years, dividend cover will remain below 1.4 times.
Hidden dividend champion
Luceco(LSE: LUCE) might fly under the radar of most investors, but that does not mean that you should ignore the business.
The company manufactures and distributes high quality and innovative LED lighting products, and business is good. For the six months ended 30 June, revenue rose 26% year-on-year and adjusted profit before tax leapt 63%. Net debt fell from £48m to £26m giving management confidence to introduce an interim dividend payment of 0.8p per share. Since these results, the firm has spent £10m to buy Kingfisher Lighting, a nationwide UK supplier of exterior lighting products.
City analysts believe that Luceco can grow earnings per share at a rate of 20% or more per annum for the next few years. I believe that, if anything, this target is conservative. The group is highly cash generative, and the market for LED lighting is still growing.
As earnings grow, so will the dividend. For 2017 a total payout of 2.1p is projected rising to 2.6p for 2018. And just like Grainger, while Luceco's dividend yield of 1% today might not look that attractive, the payout has plenty of room to expand.
For 2017, the dividend of 2.1p will be covered an estimated 5.1 times by earnings per share. If the dividend continues to grow at a rate of 25% per annum for the next five years, it will hit 8p by 2023 giving a yield of 3.6% at today's prices.
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Rupert Hargreaves owns no shares mentioned. The Motley Fool UK has recommended Luceco. 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.