Most dividend investors are influenced by the current yield when they enter a particular stock investment. Dividend growth investors are no different either. It is hard to blame either of these groups, as there is no point in a company that strongly raises its dividend payments, yet it might take up to two decades for the yield on cost to reach any meaningful level. Add in to that the fact that a double digit dividend growth could only be supported by a double digit earnings growth only for so long. If the dividend payout ratio was low at the beginning this could extend the strong dividend growth by a few years after earnings growth slows down to a more reasonable level.
Some of the best dividend growth stocks however would always spot a low current yield, coupled with strong dividend growth for many years to come. As some might typically yield 1% or 2 %, they would be completely ignored by most investors. The trick here is that a company that yields 2% today and raises its dividend by 12% every year would double your yield on cost in just 6 years. In most cases such companies stock prices also tend to follow the changes in the dividend payment, which could lead to strong capital gains over time. Thus, if the stock increased distributions by 12%, it is very likely that the stock price might increase by about 12% as well. This leaves the dividend yield unchanged at 2%, which doesn’t matter much for original investors, who purchased the stock 6 years earlier.
In my experience as a dividend investor I have always implemented a minimum yield criterion of between 2% to 3% when screening for dividend growth stocks. I implemented this control in order to protect myself in the event that the company I am heavily invested in stops raising distributions. That way I could at least receive some return on my investment until I try to unload my position above my breakeven price.
Looking back at the best dividend growth stories of Wal-Mart (WMT) and McDonald’s (MCD) however, my minimum criteria would have prevented me from getting aboard on these success stories. Other investors who are currently seeking high current income might also have missed out on these plays, which are delivering double-digit yields on cost for anyone who purchased Wal-Mart of McDonald’s in the 1980s.
I recently came out with a way to tweak my entry criteria of 3% minimum initial yield by grouping higher yielding and lower yielding investments with my purchase. At the end of the date, one could easily create a dividend portfolio which consists both of high yielders with slow to no dividend growth and low dividend yielders, which have the potential for strong dividend growth. If one manages to allocate the varying dividend components in their portfolio carefully, they would be able to achieve a target initial yield on cost for their stock holdings as a whole.
For example I recently added to my position in Wal-Mart Stores (WMT), which I consider of the best run companies in USA, with a strong position in the retail market and good opportunities for growth. The low current yield of 2.20% however was too low in comparison to the 3% entry criteria I apply for new and existing investments. I do believe however that the strong dividend growth would more than compensate for the low current yield, and I see the yield on cost on an investment in Wal-Mart today doubling to 4.5%-5% by the end of the next decade. That’s why I added the high dividend stock AT&T (T) to my portfolio. For every two shares of Wal-Mart (WMT) stock, I bought one share of AT&T (T). At the current prices this mix yields 3% right now.
I view AT&T (T) as a slow grower, which might end up cutting distributions sometime in the future due to its high payout and stagnant earnings in the highly competitive telecom market. The strong dividend growth at Wal-Mart (WMT) however should more than compensate for any potential dividend cuts at AT&T (T). If AT&T (T) cuts its dividends by 50% to 82cents/share, but Wal-Mart (WMT) managed to raise its distributions by 36%, my total dividend income would be unchanged. I believe that Wal-Mart (WMT) would be able to raise distributions by 36% over the next 3-4 years, assuming that it follows the most recent path of dividend growth.
Other stocks that I could use in dividend grouping for income could be high yielding triple net lease real estate investment trust Realty Income (O) or pipeline operator Kinder Morgan (KMP).
Full Disclosure: Long T, KMR, MCD, O and WMT
- Six Dividend Stocks for current income
- Best Dividend Picks for 2009, 3Q update
- Emotionless Dividend Investing
- Dividends Stocks versus Fixed Income
One of my favorite books on investing is “ The Snowball: Warren Buffett and the Business of Life ” by Alice Schroeder. The book describes ho...
I view each investment I make as a seed that I plant for the long-term. Some seeds could turn into a tree that would provide fruit (dividen...
In my previous article, I discussed the concept of the dividend snowball as it applies to my dividend portfolio and dividend income. The po...
I expect that this year, I will be able to cover something like 60 - 80% of my targeted annual expenses from dividends alone. This means tha...
In a previous article, I discussed that I will reach Financial Independence some time in 2018 . After I reach the dividend crossover point ,...
One of my largest holdings is McDonald’s (MCD). The company recently raised its quarterly dividend by 4.7% to 89 cents/share. McDonald's...
In a previous article titled, My Dividend Retirement Plan , I outlined the concept of the dividend crossover point. This happens when your d...
One of the biggest mistakes I ever made was not maxing out my 401 (k), IRA and HSA accounts between 2007 and 2012. As a result, I ended up ...
The more I learn and experience about investing, the more convinced I become that doing nothing is the best strategy for long-term success i...
I started my site dedicated to dividend investing in January 2008 . I had been able to accumulate some money for the first time in 2007, and...