Albert Einstein once said that compound interest was the eighth wonder of the world. What he meant was that the earning power of reinvested interest can transform your wealth with very little effort.
I believe that dividend growth investing is like compound interest on steroids. As the value of the dividend income you receive grows each year, the value of the underlying shares tends to rise too, as the market prices-in a higher income.
The total returns from this style of investing can be impressive. So today I’m going to look at two stocks I believe could be excellent dividend growth buys.
Should you invest £1,000 in Aviva right now?
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A sticky business
One way to identify potential dividend growth stocks is to focus on companies with ‘sticky’ customers. Typically this means selling a product or service that’s hard to replace.
I believe AIM-listed healthcare software firm Emis Group (LSE: EMIS) fits this description. This £622m company provides a wide range of software for the NHS, including patient record systems, pharmacy software and other more specialist services.
The company’s three main divisions have UK market share of between 26% and 56%, according to today’s interim results. In all, 84% of the group’s revenue is recurring — based on subscription services or annual renewal.
A strong market share combined with high levels of recurring revenue make it easy for companies to gauge their future profits and cash flow. This also makes it easier for management to provide consistent dividend growth.
This promise is reflected in today’s half-year results. Total revenue rose by 1% to £79.2m during the first half. Although the group’s adjusted operating profit fell by 1% to £17.5m, this still gives an impressive adjusted operating margin of 22%.
Even better is that cash generation improved. Emis’s net cash balance rose to £10.5m, from £0.7m one year ago.
Management expects the group’s performance to be stronger during the second half of the year. To reflect its strong cash position, the interim dividend has been increased by 10%, to 12.9p.
Dividend growth has averaged 13% per year since 2011, and although the forecast yield of 2.5% is quite modest, I believe this business has the potential to provide inflation-beating dividend growth over long periods.
How about a 5.1% yield?
If you’re looking for more upfront yield, then the FTSE 100 can be a good place to look. One of the largest holdings in my personal portfolio is insurance group Aviva (LSE: AV).
Under chief executive Mark Wilson, Aviva has been refocused to deliver sustainable growth backed by strong cash generation. Mr Wilson’s efforts so far have been very successful, in my view. But the market has remained fairly cautious.
The group’s shares currently trade on less than 10 times forecast earnings, and offer a prospective dividend yield of 5.1%. The dividend is expected to rise by 12% this year and by 7% in 2018. It’s worth noting that this rate of growth is well above inflation and average wage growth.
Aviva’s finances are much stronger than they were a few years ago. I believe that patient shareholders are likely to enjoy steady dividend growth over the coming years. I’ve no intention of selling my shares just yet.
