1 Magnificent Dividend Growth Stock That Can Outperform the S&P 500

Investors love dividends for their durability and stability during volatile markets. As anyone who has paid attention to the last five years is aware, we have seen quite volatile markets (both upward and downward). Steady dividend payments can help you weather the volatility storm.

But what's an investor to do when the S&P 500 only pays an average dividend that yields 1.32%? That is not much annual income and significantly worse than the return you can get owning short-term Treasury bills at the moment.

Investors need to look for stocks with high starting dividend yields that also have the earnings growth to propel these dividend payments higher year after year. These stocks are few and far between with the market at all-time highs.

One stock that fits this criteria is Philip Morris International (NYSE: PM). This misunderstood nicotine giant is posting strong revenue and earnings growth and currently has a dividend yield above 4%. Here's why this dividend growth stock can outperform the S&P 500 over the next decade.

Growth from safer nicotine products

Philip Morris is mainly understood as a seller of cigarettes outside the United States, with brands including Marlboro and Chesterfield. This is not the full picture of the business today and hasn't been for many years.

Through internal investments and acquisitions, the company has greatly expanded its operations away from cigarettes to include heat-not-burn tobacco, electronic vapor, and nicotine pouches. These are known to be less harmful ways to consume nicotine and have been gaining market share versus cigarettes for over a decade now with Philip Morris leading the industry in this shift.

Last quarter, these new-age nicotine products made up 38% of the company's overall revenue and are growing faster than its consolidated business. Through strong growth from Zyn nicotine pouches in the United States and Iqos heat-not-burn devices in Europe and Japan, Philip Morris' smoke-free division grew sales 16.8% year over year last quarter. Gross margin improved due to more scale, leading to 20.2% gross profit growth for the segment.

As these products take over the nicotine market in the next decade or two, they can drive revenue growth for many years into the future.

Stable profits from legacy cigarettes

Don't sleep on the old-school cigarette business for Philip Morris International. Through consistent price increases, the company has been able to grow its earnings for a long time from this segment.

Overall cigarette prices for the company have grown by 5% or more per year in 2022, 2023, and so far in 2024. This is why cigarette revenue grew 8.6% last quarter.

I suspect Philip Morris will be able to grow cigarette sales through price increases for a long while. But even if nicotine consumers suddenly stop smoking due to price hikes, the company will be able to retain these customers with its leading nicotine pouch and heat-not-burn brands (Iqos and Zyn). This is a robust strategy that lets Philip Morris profit from whatever way the nicotine sector turns.

PM free cash flow per share, data by YCharts; TTM = trailing 12 months.

The dividend growth algorithm

As of this writing, Philip Morris has a dividend that yields 4.4%. It currently pays a dividend per share of $5.25, which is easily covered by its $6.46 in free cash flow per share. Both figures have steadily climbed over the last 10 years, and I suspect they will over the next 10 as well.

With the rapid growth of new-age nicotine devices, revenue should grow by at least 5% to 10% per year for the next five years. Add in profit margin expansion from increased scale, and I believe free cash flow per share can grow north of 10% for a long while. This means management will have the ability to raise its dividend per share by 10% annually.

The math looks favorable under this scenario for investors who hold on for the long term. If Philip Morris' dividend per share compounds at 10% a year for 10 years, the dividend yield will climb to 11% in 10 years. That is compared to the current share price of $124. Under this scenario, the stock is likely higher, too, meaning investors appreciate dividend income and stock appreciation as they build their wealth owning this stock.

This combination is the beauty of buying a dividend growth stock, and why Philip Morris International is set to crush the S&P 500 index over the next 10 years.

Should you invest $1,000 in Philip Morris International right now?

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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool recommends Philip Morris International. The Motley Fool has a disclosure policy.