At first glance, the dividend yield of CSX (NYSE:CSX) is miserable at just 1.24%. However, when you consider the capital appreciation that has come along with the dividend income paid out over the years to shareholders of CSX stock, it’s not nearly as awful as you might think.
In fact, it’s downright excellent, but not every dividend investor is interested in both income and capital appreciation. Some buy dividend stocks purely for the income. Consider an equity like Altria Group (NYSE:MO), which yields 6.6% and generates a significant amount of free cash flow. MO is far more attractive to someone looking to park their money in a relatively safe place other than bonds.
That said, I think most dividend investors ought to consider owning CSX stock. Here’s why.
It’s Not the Yield That Counts
If all you invest in are dividend aristocrats, you would have missed out on CSX stock. Although the company has paid a dividend since 1922, it has only increased its dividend for 14 consecutive years. That makes it ineligible for aristocrat status, which require 25 years of increases to qualify.
Investors get caught up in the yield when it is the growth of the dividend payment that truly matters. Consider CSX’s dividend history over the past 14 years.
In 2005, it paid out $0.43 in dividends. Based on its midpoint share price between its high ($51.60) and low ($36.90) that year, it averaged a 0.97% yield. In 2005, management increased the dividend by 7.5%.
In 2018, CSX paid out $0.88 in dividends, 12.8% higher than in 2017. Based on its midpoint share price between its high ($76.24) and low ($48.43), it averaged a yield of 1.4%. That was 44% higher than 14 years earlier.
Overall, CSX has increased its annual dividend between 2005 and 2018 by 5.7% compounded annually.
And what about earnings growth?
In 2005, CSX’s continuing operations earned $3.17 a share. In 2018, it earned $3.84 a share from its continuing operations. That’s an earnings growth rate of 1.5%, less than a third the growth of its dividend.
I must admit, as I look at these numbers, I get a little concerned about recommending CSX stock. After all, it’s generally preferable for the earnings growth rate to exceed the dividend growth rate.
In this case, one can look to the payout ratio for part of the answer.
This past year, CSX paid out 23% of its earnings for dividends. In 2005, it paid out just 14% for dividends. Those are incredibly conservative payout ratios, especially considering how much free cash flow it generates.
Free Cash Flow Is Growing
In the past three fiscal years, CSX has grown its adjusted free cash flow from $847 million in 2016 to $1.7 billion in 2017 and $3.2 billion in 2018. That’s good for a compound annual growth rate of 94%.
In these three years, CSX’s conversion ratio (free cash flow divided by revenue) went from 7.7% in 2016 to 14.9% in 2017. Then, in 2018, the ratio increased to 26.1%. As the company grows its conversion rate, it has more money to reward shareholders through dividends and share repurchases. Additionally, CSX can make acquisitions, repay debt, and invest in the existing business.
That should drive the CSX stock price higher.
In 2005, CSX converted 12% of its revenue ($8.6 billion) to free cash flow ($1 billion). Over the past 14 years, the railroad has continued to be a strong generator of cash. This is a big reason why its equity has delivered a total return of 569% over the past 10 years. For comparison, that’s almost double the S&P 500.
Yes, railroads in general have done well over the past decade, but CSX stock has led that pack.
The Bottom Line on CSX Stock
InvestorPlace contributor Thomas Niel recently wrote that a combination of a slowing economy and an excessive valuation makes CSX stock a bad buy for those looking for a quick return.
However, he did concede that it’s likely still a buy for long-term investors. I couldn’t agree more.
As long as CSX management continues to control expenses and allocate free cash flow, slower growth shouldn’t be as big a problem as you might think.
It might not yield a lot, but it sure has delivered for shareholders over the past decade. I expect it to do the same over the next 10 years.
At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.