One of the Best Dividend Stocks Is a Company You’ve Never Heard Of
December 3, 2019
One of the Best Dividend Stocks of the Past Decade
If you ask most people to name the best dividend stocks, they’ll rattle off a similar list of household names. Few, however, would mention this little-known company: First American Financial Corp (NYSE:FAF).
Since late 2009, this insurance stock has increased its quarterly distribution sevenfold. Over the same period, First American Financial stock has delivered a total return, including reinvested dividends, of 487%. That beat the pants off the broader S&P 500, which gained only 183% during the same time frame.
Not that many people have noticed though. Only a handful of Wall Street analysts follow the company, and FAF stock receives little coverage from the financial press. Maybe income investors should take notice.
Here’s why.
Long-time readers know I’m a big fan of the insurance sector thanks to a quirk in the industry’s business model. Customers always have to pay their premiums up front, but it could be months or years before they file a claim. This results in a big pile of money, called the float, which is just sitting on the company’s balance sheet.
Insurance companies can invest this float as they see fit. That means they can pocket any dividends, interest coupons, and capital gains in the time before customers need to be reimbursed. In essence, this amounts to an interest-free loan.
No other industry enjoys this type of competitive advantage. Banks pay interest to depositors and companies pay dividends to shareholders. But insurers can finance their business basically for free. For this reason, insurance stocks as a group have crushed the broader stock market for decades.
But here’s what separates First American from its peers. The company doesn’t compete in competitive segments like automotive, property, or casualty. Instead, management has carved out a lucrative niche in title insurance, protecting homeowners against challenges to the ownership of their property.
As the largest player in this business, First American Financial Corp has access to more and better records than any of its peers. This allows its executives to set better price policies, protecting shareholders from unexpected claims in the future. Size also allows the firm to spread its fixed costs over a wider base of sales, ensuring that more revenue dollars flow to the bottom line.
That has turned the business into a money machine. Since 2014, First American has generated an average of $0.12 in annual profit on every dollar that shareholders have invested into the company. Such returns put the business in the same league as some of the best dividend stocks in the world.
What does management do with all of this cash? When a good opportunity presents itself, executives use their retained earnings to grow their business. But for the most part, they pay the bulk of their profits out to investors.
Like clockwork, First American has boosted its dividend every year since 2010. The board approved payments of $0.84 per share in 2014, $0.99 in 2015, $1.20 in 2016, $1.44 in 2017, and $1.60 in 2018. (Source: “Dividend History,” First American Financial Corp, last accessed November 26, 2019.)
(Source: “Dividend History,” First American Financial Corp, last accessed December 2, 2019.)
For full-year 2019, the business is on track to pay out $1.68 per share in dividends. That comes out to a forward yield of 2.7%, nearly a full percentage point higher than the yield from the S&P 500. (Source: Ibid.)
Of course, you can’t call this business a slam dunk. First American’s revenues rise and fall with the real estate market. So if home sales drop, so too will the company’s pace of dividend hikes.
That said, this quiet, little-known company has penciled out a profitable business. That has made it one of the world’s best dividend stocks of the past decade. And if history is any guide, it could be a top dividend stock of the next decade, too.
