2022 was a great year for dividend growth stocks. The whole category out-performed the S&P 500, while energy stocks (a subset of dividend growth stocks) earned a 58% capital gain! The performance between different dividend-paying sectors varied quite a bit, but even financials–among the weaker performing dividend sectors–managed to beat the S&P 500 by about 5%.
Now, it’s not hard to see why this happened. It’s not really that dividend stocks did all that well as that tech stocks–which mostly don’t pay dividends–did extremely poorly. The Vanguard Dividend Appreciation ETF (VIG) declined about 11% for the year, or 8.5% after dividends. That’s not exactly an amazing showing, but compared to the NASDAQ-100’s 33% selloff, it’s great.
Heading into 2023 I expect dividend stocks to keep doing well on average. I’m no longer sure that they will vastly out-perform the indexes, but they have the potential to do well. Banking stocks, for example, performed poorly in 2022 despite net interest income rising. I’d expect them to gain relative to most other stocks this year. Additionally, there is potential for strength in dividend paying technology stocks, as I will explain shortly.
In investing, nothing is ever 100% certain. But with interest rates continuing to rise, there are good reasons to invest in value stocks and dividend growth stocks. With that in mind, here are my top four dividend growth stocks for 2023.
Taiwan Semiconductor Manufacturing (TSM)
Taiwan Semiconductor Manufacturing is a Taiwanese technology company that, as the name implies, manufactures semiconductors (aka computer chips). It is a semiconductor foundry, which means that it takes blueprints from other companies and uses them to assemble completed chips. This is a lucrative business model because semiconductor manufacturing is, in itself, a very profitable business. Even if you’re using someone else’s blueprints, the physical manufacturing of chips is very capital intensive, requiring lithography machines that cost hundreds of millions of dollars and can only be operated by very skilled technicians.
Because of the complexity of its operations, TSM enjoys an economic moat. It makes 65% of the world’s semiconductors and near 90% of extremely advanced chips. It’s an impressive market share, yet the company’s stock is still cheap, trading at:
12.65 times earnings.
5.8 times sales.
4.4 times book value.
A 0.24 PEG ratio.
Eight times cash flow.
This company looks super cheap. Of course, the low PEG ratio will be called into question if the growth slows down but it was growing revenue at 36% last quarter when other semi companies’ growth had already turned negative, so there’s clearly some resilience here.
TD Bank is a dividend stock I’ve held for a long time now. I have written about it in several Seeking Alpha articles. It has a 4.5% yield at today’s prices, it hiked the dividend by 8% after the most recent quarterly release.
What does TD have going for it this year?
Like most banks, it benefits from rising credit card spending, which has been reported by Mastercard (MA) and others. Also like most banks, it stands to gain if the expected 2023 recession is mild rather than severe, as its 22% price decline (from all-time highs) appears to price in much more than just “mild” economic turbulence. The two points just mentioned apply to most North American banks. Why, then, do I single out TD in a list of just a handful of stocks?
It comes down to catalysts.
TD has two big acquisitions on the horizon, both of which could take earnings higher.
First, there’s the First Horizon (FHN) deal. TD has a deal in the works to buy FHN for $13.4 billion. FHN has $861 million in ttm net income. Its most recent quarter’s earnings would produce $10.76 billion in earnings if repeated for the next three quarters. So, TD could add about $1.076 billion in earnings by closing the FHN deal. The deal is facing some regulatory scrutiny, so closing isn’t a sure thing, but if it does close, then TD will get a quick earnings boost.
Next up, there’s Cowen (NASDAQ:COWN). That company does $128 million in annual earnings. As an investment bank, it’s not doing great this year: its earnings are declining. However, those declining earnings are why TD was able to buy it at a slight discount to its all-time high. The FHN deal was criticized on valuation grounds, it’s hard to say the same thing about the Cowen deal which, should it close, will push TD’s 2023 deal-related earnings over $1.1 billion.
Bank of America (BAC)
Bank of America is a stock I bought all year long last year, and have been very excited about in general. A few of the points I mentioned about TD apply here too; namely, rising credit card spend and a possible positive reaction to a merely-mild recession. However, Bank of America scores a little better than TD on one specific factor:
Banks issue mortgages, and mortgage defaults are a major source of bank risk during recessions. When people lose their jobs, they tend to default on their mortgages. It’s a big risk for banks. Bank of America is less exposed to it than TD is.
Bank of America does almost all of its lending in the U.S., TD does 60% of its lending in Canada. This is a risk for TD because the average Canadian house is far more expensive than the average U.S. house. At the height of Canada’s housing bubble, Canadian homes cost nearly twice as much as U.S. homes, or 1.6 times more in nominal terms. Today, the gap is narrower, but Canadian houses are still more expensive. According to The Zebra, a U.S. house costs $348,000 on average. According to the CBC, the average Canadian house costs C$632,000. The current CAD/USD exchange rate is 0.74, so the average Canadian house costs $464,000 in PPP terms. Americans have slightly more after-tax income than Canadians do, so it would appear that Americans are less at risk of mortgage defaults this year compared to Canadians. This factor helps Bank of America, relatively speaking, as it does much more U.S. lending than TD does.
Beyond that, Bank of America stock is cheap, trading at 10.5 times earnings, 2.98 times sales, and 1.12 times book value. Overall, it’s a great dividend growth stock.
Last but not least, we have Apple Inc. This is a stock I’ve covered extensively in past articles. Unlike Bank of America and TD, Apple fell compared to where it was when I last covered it, so naturally, I got more interested.
Apple stock is not exactly bursting with yield. At today’s prices, it yields just 0.53%, which isn’t much. However, it has a 9 year dividend growth streak. To be honest, even if a company raises its dividend every single year, it will take some time to get a hefty yield when it’s starting from 0.53%. However, dividend growth is in itself a good signal. A company can pay an unsustainable dividend for a while, it takes real strength to keep paying dividends for decades. In this light, Apple’s dividend growth track record speaks for itself.
What else does Apple have going for it?
Unlike a few other stocks on this list, it’s not exactly a value play. Trading at 20 times earnings and 39 times book value, it’s far and away the most expensive stock I own. What Apple does have going for it is its competitive position. It has the world’s most valuable brand, and an inter-connected ecosystem of software and hardware offerings that incentivizes buying multiple products instead of just one. As a result of its ecosystem, Apple collects a high level of revenue per user. Definitely a great company.
The Bottom Line
The bottom line on dividend growth stocks is that they’re some of the best assets you can buy. Like all dividend stocks, they offer income, but unlike certain high-yield names, they tend to have very strong business performance. Personally, I’m going to be buying a lot of dividend growth stocks this year. If you’re interested in doing the same, any one of the four names above would be a great place to start.