The idea of dividend growth stocks is almost a contradiction. Growth involves reinvesting profits to generate higher earnings and dividends involves paying out earnings to shareholders.
Managing to do both is something of a fine art, but FTSE 100 conglomerate Bunzl (LSE:BNZL) has found a way to do it. And I think the stock looks like a great investment as a result.
A growing business
According to Warren Buffett, the best businesses have two features. One is the ability to generate a lot cash without high capital requirements and the other is the ability to do this for a long time.
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Bunzl has both. As a distributor, it doesn’t have to buy machinery or materials, which means 95% of the cash it generates through operations becomes available for growth, dividends, and share buybacks.
In terms of low investment requirements, this is impressive. It compares favourably with companies like Tesco (68%), Unilever (78%), and even Coca-Cola (85%).
A lot of Bunzl’s growth comes from acquiring other businesses. And the company focuses on firms that have dominant positions in niche areas, making them difficult to disrupt.
These businesses can benefit from the increased scale that comes with being part of Bunzl’s organisation. And they provide the parent company with a durable source of cash.
Dividends
Bunzl shares currently come with a dividend yield of around 2%. That isn’t the most eye-catching, but the company’s shareholder distributions have increased roughly in line with revenue growth.
A dividend increasing at 7% per year is impressive. That’s significantly outpacing the growth at companies like Diageo (4.7%), National Grid (1.5%), and Aviva (4.7%).
If the company can keep this growth going, the dividend should roughly double every 10 years. So, by 2043, the stock should be providing around 8% each year on an investment at today’s prices.
Maintaining that growth won’t be straightforward in an era of higher interest rates. And there’s a risk of low returns if the company can’t keep moving things forward.
Bunzl’s management, though, has a strong record in this regard. And with a wide opportunity set available, I think buying the stock at today’s prices could turn out very well.
Passive income
A stock with a 2% dividend yield isn’t an obvious place to start looking for passive income. Earning £1,000 per year in passive income would take around £50,000 today.
That’s less than I could currently earn in cash or bonds. But I don’t think either cash or bonds has the potential for increasing returns that Bunzl shares do.
If the dividend continues to grow at 7% per year, an investment yielding £1,000 per year today will generate £4,000 after 20 years. And reinvesting the dividends could bring even bigger returns.
If the stock continues to trade with a 2% dividend yield, I could increase my stake by around 50% by reinvesting my passive income. That would mean I’d get around £6,000 per year.
Buying 1,064 Bunzl shares to get £1,000 in passive income this year would take a big outlay. But I think there’s significant potential for significant returns in the future with this stock.
