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The idea of dividend growth stocks is almost an oxymoron. Growth involves reinvesting profits to generate higher profits, and dividends involve paying profits to shareholders.
Managing to do both is something of an 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 companies have two characteristics. One is the ability to generate a lot of cash without high capital requirements and the other is the ability to do so for a long time.
Bunzl has both. As a distributor, you don't have to purchase machinery or materials, meaning 95% of the cash you generate through operations is available for growth, dividends, and share buybacks.
This is impressive in terms of low investment requirements. Compares favorably with companies such as tesco (68%), Unilever (78%), and even Coca Cola (85%).
Much of Bunzl's growth comes from acquiring other businesses. And the company focuses on companies that have dominant positions in niche areas, making them difficult to disrupt.
These companies can benefit from the greater scale that comes with being part of the Bunzl organization. And they provide the parent company with a lasting source of cash.
Dividends
Currently, Bunzl shares have a dividend yield of around 2%. That's not the most flashy thing, but distributions to the company's shareholders have increased roughly in line with revenue growth.
A dividend that increases 7% annually is impressive. This is significantly outpacing the growth of companies like Diageo (4.7%), National Network (1.5%), and Aviva (4.7%).
If the company can maintain this growth, the dividend should roughly double every 10 years. So by 2043, stocks should provide about 8% each year on an investment at current prices.
Maintaining that growth won't be easy in an era of higher interest rates. And there is a risk of low returns if the company cannot continue moving forward.
Bunzl management, however, has a solid track record in this regard. And with a wide set of opportunities available, I think buying shares at current prices could do very well.
Passive income
A stock with a 2% dividend yield is not an obvious place to start looking for passive income. Earning £1,000 a year in passive income would require around £50,000 today.
That's less than you could currently earn in cash or bonuses. But I don't think either cash or bonds have the potential to increase returns like Bunzl stock does.
If the dividend continues to grow at 7% per year, an investment yielding £1,000 a year today will return £4,000 after 20 years. And reinvesting the dividends could generate even higher returns.
If the stock continues to trade at a 2% dividend yield, I could increase my stake by about 50% by reinvesting my passive income. That would mean he would earn around £6,000 a year.
Buying 1,064 Bunzl shares to earn £1,000 in passive income this year would be a big outlay. But I think there is a lot of potential for significant future returns from this stock.
