I like to think of Dividend Growth as your secret weapon in the fight against low yields.
The power of dividend growth isn’t really a secret, obviously. But I call it a secret weapon because a lot of investors don’t realize just how powerful dividend growth is.
Take, for example, Wal-Mart Stores (WMT). Right now WMT trades around $72 and pays $1.88 in dividends annually, for a current yield of 2.6%.
($1.88/$72.00) x 100 = 2.6%
(annual dividend/price) x 100 = yield
That’s not terrible.
But a lot of investors are getting much higher yields from WMT now.
How? They bought it when the stock price, and the dividend payout, were lower.
Five years ago, WMT was trading at $59 and paying $0.96 in annual dividends. At that time, the current yield was only 1.6%.
($0.96/$59) x 100 = 1.6%
That might not have been a good enough yield to convince you to put WMT in your income portfolio. But if you did, and you hung on for five years, then your yield on cost today would be:
($1.88/$59) x 100 = 3.2%
(annual dividend/purchase price) x 100 = yield on cost
That’s double your original yield.
And the longer the holding period, the more powerful dividend growth can be.
Wal-Mart has raised its dividend every year since 1974. If you bought 20 years ago, in 1993, when Wal-Mart was trading at $13 (split-adjusted), then your yield on cost today would be:
($1.88/$13) x 100 = 14.5%
That means that every year, WMT’s dividends alone are handing you a dependable 14.5% return on your original investment. Every year! Not bad for a 2.6% yielding stock.
Of course, hindsight is 20/20.
If you want to harness the power of dividend growth today, you have to find a stock with the potential for future dividend growth.
A couple factors determine a stock’s potential for dividend growth.
• The most important is cash flow growth. If the money coming in isn’t increasing, the money going out can’t increase.
• Also important is the company’s payout ratio. That’s the amount of free cash flow that they pay out as dividends. A lower payout ratio means more room for growth.
Finally, while both those factors show potential for dividend growth, you also need to consider the real likelihood of dividend growth. If the company isn’t inclined to raise its dividend, it’s not going to happen.
• The best indicator of the likelihood of dividend growth is actually the past. Companies that have regularly raised their dividend in the past—like Wal-Mart above—are more likely to keep doing so going forward.
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In the last Dividend Digest, Jack Adamo of Global Dividend Investor considered all three factors in his recommendation of B&G Foods (BGS). Here’s part of his recommendation:
“B&G Foods, Inc. (BGS) makes branded and generic prepared foods. ... In 2012, pre-tax earnings were up 18.4% on 16% pre-tax margin, a nice improvement over 2011’s 14.1% margin and 12.5% growth. Net EPS rose 15.4%. Operating cash flow has been consistently higher than earnings, and was 40% higher in 2012. Return on equity has doubled over the last three years from 12% to 25%. The company is expected to grow EPS 14% from $1.56 in 2013 to $1.78 in 2014. ...
“B&G’s dividend yield is 3.7% and has grown at a smile-inducing 11.3% per year for the last five years. At 79%, its payout ratio is high, but it is coming down. Last year, it was nearly 90%. ... Buy B&G Foods up to $38.” - Jack Adamo, Global Dividend Investor, 7/30/13
BGS yields 3.7% right now. But it has excellent potential for dividend growth, and investors who buy today may find themselves reaping much larger profits down the line.
Unlike B&G Foods, EMC Corp. (EMC) doesn’t have a long history of dividend increases. In fact, the company just started paying a dividend this year. And right now, it only yields 1.5%. But EMC is a perfect candidate for dividend growth. Here’s what Dow Theory Forecasts Editor Richard Moroney wrote about it in the latest Dividend Digest:
“EMC Corp. (EMC) took a friendlier stance toward shareholders in May, initiating a quarterly dividend of $0.10 per share and approving a $6 billion stock buyback through 2015. EMC is part of the migration of technology stocks toward dividends. ... EMC has also begun to leverage its balance sheet, with the issuance of $5.5 billion of bonds.
“EMC entered the June quarter holding $6.53 billion in cash, the result of higher free cash flow in 13 of the past 16 quarters. EMC has said it seeks to return more than half of its free cash flow to investors through stock buybacks and dividend payments; the current dividend represents no more than 25% of free cash flow. EMC, yielding 1.7%, is a Long-Term Buy.” - Richard J. Moroney, CFA, Dow Theory Forecasts, 7/8/13
Do you have any dividend growth success stories in your portfolio? Let me know by replying to this email.
Wishing you success in your investing and beyond,
Chloe Lutts Jensen
Editor of Investment of the Week
