Jeremy Glaser of Morningstar.com talked to Josh Peters, Editor of Morningstar DividendInvestor about the potential of rising interest rates in the future and the impact that could have on dividend paying stocks.
One stock Josh Perters recommended is Paychex:
The other thing that I would look at is trying to find situations that are more driven by dividend growth perhaps than high current yield. One of my favorite names that falls in this category, one of my favorite names period is Paychex, the small business payroll processor.
Now, a lot of people look at its four plus percent yield and say that's looks really great, but what about that 90% payout ratio. Doesn't that mean the dividend could be cut? Actually, Paychex is a business that is so efficient with its capital, needs to reinvest so little in order to grow that it gears itself towards 75% payout ratio even under normal times. They have no long-term debt, a lot of cash, very good cash flow that covers the dividend even better than earnings does. There is plenty of reasons to think that the dividend is safe.
If we start thinking about growth, Paychex's earnings are really driven by three factors; one is, small business employment because they charge per check; the second is, how much are they able to charge for a check. We think Paychex is a wide moat business it's hard for customers to just switch easily payroll providers on a dime. So we figure that they'll be able to raise prices at least as fast as inflation; and then the third is interest rates. They actually make money, interest income on the funds that represent uncashed payroll checks. So, it's essentially money that is free to them. It's called float.
These three forces are all cyclically aligned in that. If the economy is picking up and yet maybe that comes with higher inflation in interest rates, but Paychex's earnings probably start to grow pretty fast and the dividend probably starts to grow again. It probably won't be the very rapid growth that it's had in the past, but the last two years the company hasn't raised its dividend. I think next year or even as early as next year if the economy cooperates, we can start to see Paychex's dividend rise again.
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Read the full transcript at Morningstar.com.