3 Great Income Stocks That Could Double Their Dividends

By Markets Fool.com

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Dividend stocks are the cornerstones of a well-constructed retirement portfolio. But when you pay for shares, you're buying more than the current yield -- you're buying the potential for greater and greater payouts over time.

Consider this: If you bought shares of Johnson & Johnson fifteen years ago, you would have been buying a stock offering a $0.72 dividend annually, per share. At the time, that equated to about a 1.3% yield. But today, the stock offers up $3.20 annually in dividends. In other words, if you had held this stalwart through the years, you'd be getting a nice 5.6% yield today on your cost basis.

The three stocks I'm discussing today have the same potential for dividend growth.

Lowe's has tons of cash on hand, and a business that's steadily improving

Lowe's (NYSE: LOW) is the part of the duopoly in America's home improvement industry, with a 17% market share that's second only to Home Depot, which clocks in with a 24% share. But don't let its second-place standing fool you; the company has enormous potential as a dividend payer.

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Currently, the stock only yields 1.8%. But there's much more to the story than that. Namely, Lowe's has increased its dividend by an average 21% per year over the past five years. That's a torrid streak. And yet, over the past 12 months, the company has only used only 23% of its free cash flow to pay out its dividend.

To put it another way, Lowe's could double its dividend overnight, and it would still be using less than half of its free cash flow to pay its dividend. Right now, much of that excess cash is being used to repurchase shares, so an overnight doubling isn't likely. But I also wouldn't be surprised to see substantial dividend hikes moving forward.

Sherman-Wiliams: More exciting than watching paint dry

Clearly, business has been good in the home improvement industry, because the second stock on our list today is paint specialist Sherman-Williams (NYSE: SHW). According to some analysts, the company owns 60% of the professional paintermarket, making it far and away the biggest market player. Plus, Lowe's and Home Depot are some of the biggest retailers of Sherman-Williams' paints.

Like Lowe's, the company's dividend yield today appears puny at first sight: It's just 1.2%.

But like Lowe's, there's much more than meets the eye. Over the past 12 months, Sherman-Williams has used just 16% of its free cash flow to pay out dividends. That's ridiculously low. The yield could triple in short order and the dividend would still eat up less than half of the company's free cash flow.

Not surprisingly, during the company's last conference call, CEO John Morikis announced that the company was raising its payout by 25% year over year. If free cash flow figures remain even remotely similar to where they are now, I wouldn't be surprised to see 2015's payout double within five years.

Cardinal Health proves it pays to be a big player in healthcare

Finally, we take a step outside of home improvement and into healthcare. Cardinal Health (NYSE: CAH) has slowly become something of a healthcare conglomerate, as it manufactures everything from surgical gloves to medical safety devices and, in a joint venture with CVS Caremark, runs the largest generic drug source operation in the country.

The company also sports a 2.2% dividend yield with lots of potential for improvement. Over the past five years, Cardinal Health has bumped its dividend up by 15% per year. And yet, over the last 12 months, the company has used just 19% of its free cash flow to pay shareholders.

By now, you know the math: The company could double its dividend output and still be left saving over half of its free cash flow for other purposes. During the past year, the company spent just as much money buying back stock as it did paying out dividends. It also recently announced a 16% bump to its dividend for the next fiscal year.

CFO Michael Kaufmann, on the last conference call, said that the company expects to continue paying a yield equal to 30% to 35% of earnings(not free cash flow). To put that in perspective, the dividend was equal to 31% of earnings over the past year, and -- based on estimates -- is expected to be 32% of earnings next year.

If Cardinal Health can continue growing EPS by 10% per year, there's no reason to doubt the dividend will likewise grow.

Technically, all three of these stocks have the cash flows to double their dividends immediately. That's not likely to happen in the real world, but that's OK. All three of them have the ability to continually raise their payouts -- meaning a purchase today could yield far more a decade from now.

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Brian Stoffel has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Johnson and Johnson. The Motley Fool recommends CVS Health, Home Depot, and Sherwin-Williams. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.