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Ideas for Income Investors. High Dividend Stocks, Mutual Funds etc.
The Secret Ingredient of Dividend Growth Stocks
Posted by: Dividends4Life (IP Logged)
Date: December 6, 2012 04:14PM
When people learn that I am an income investor it is not uncommon for them to ask why I invest in stocks instead of other "safer" alternatives such as bonds, high yield money market accounts (MMAs) or certificates of deposits (CDs). I generally start with my short answer of, "Dividend stocks have a secret ingredient that makes them a much more desirable investment."
Needless to say this usually piques their interest and normally the response is something like, "Secret ingredient? What secret ingredient?" Then I explain.
Dividend Stocks Hidden Power
Let's assume you can find a CD that earns a similar rate as the dividend stock (a stretch now days, but stay with me) and it is federally insured, thus protecting the purchaser from loss. So it must be better, right?
What separates good dividend stocks from bonds, MMAs and CDs is a hidden power not readily recognizable to the uninitiated - dividend growth. While a CD will pay a market interest rate for its term, its only growth is movement in the market rate at renewal, which can go either up or down. Contrast that with a good dividend stock with decades of consecutive annual dividend increases.
Dividend Stocks Yield On Cost
One way to compare the earning power of two investments or an investment and a CD is to look at their Yield on Cost (YOC) over time. YOC is a simple concept where you divide annual earnings over the investment's original cost. Consider this simple example of a stock with a 2.75% yield and a dividend growth rate of 7%, compared a five-year CD paying 3.00%, where earnings in both are withdrawn when paid:
Though the dividend stock started with a lower yield of 2.75%, its final YOC after 5 years was 3.6% compared to the constant 3.0% of the CD. The key here is to find dividend stocks that are growing their dividends and will continue to do so. Since these numbers are contrived, the obvious question is how does this translate to the real world?
Dividend Stocks The Last 10 Years
Below are some bellwether dividend growth stocks and their performance over the last 10 years, assuming the stock was bought at the stock's 2002 high price:
Quote:The above data demonstrates another important concept — your starting point is very important. Ten years ago the stock market was higher in relative terms than now, thus the yields for most companies were lower than now. After 10 years of growth, the YOC is not much higher than the stocks current yield for several of the companies. However, similar growth over the next 10 years will produce a dramatically higher YOC. Just look at MCD to get an idea of what superior growth will do to YOC.
Full Disclosure: Long KO, JNJ MMM, MCD ABT. See a list of all my dividend growth holdings here.
- 10 Dividend Stocks That Gave Me A 20%+ Annualized Return
- All Investments Carry Risk
- 9 Stocks Delivering The Dividend Dream
- 10 Quality Dividend Stocks Trading Below Their Fair Value
- Warren Buffett's Two Investing Rules For Dividend Investors
Stocks Discussed: KO, JNJ, MMM, MCD, ABT,