Tuesday, June 10, 2014

Dividend Growth Stocks are Compounding Machines

Compounding is one of the eight wonders of the world. The steady methodical reinvestment at a particular rate of a return, over a period of time results in a much larger amount in the future.

In my studies of dividend growth stocks I have always be amazed how otherwise large, boring, and slow growing enterprises can end up delivering outstanding returns to their shareholders. Most people on the street believe that the way to make money in stocks is by finding a company that can double your money overnight. Many of those lose thousands of dollars each year, trying to find a method to identify the next Microsoft, Google, Amazon, Tesla etc. At the same time the blue chip dividend stocks that provide spectacular long-term results are familiar to everyone, are usually selling at decent valuations, and provide steady a dependable growth of their earnings and dividends. All the while the first group of investors is looking for the best get rich quick scheme, the investors in the mature dividend growth stocks are quietly compounding their wealth and dividend incomes.

The largest gains are harvested by those that have the patience to buy a portfolio of quality dividend growth stocks, patiently reinvest dividends into more quality dividend paying stocks over long periods of time. To someone who doesn’t want to open their mind to the world of successful dividend investing, a 3% current dividend yield and a steady 6% annual dividend growth does not sound glamorous at all. To an investor with a vision however, this is seen as $400 in annual dividend income on a $1000 investment in 30 years. In other words, this investor will be getting massive amounts of dividend income in the future, for a decision they made 30 years before. If we extend the time period to 40 years, the annual dividend income will be close to $960. Those are of course extremely conservative estimates, as they are close to the historical growth in dividends in US stocks on average throughout most of the 20th century.

In essence, those companies earn excess cash flows. After they reinvest cash in the business in order to maintain and increase the size of operations, there is a plenty of cash left over. They are then sending those growing piles of dividend checks to their shareholders. If you are drowning in liquidity, you cannot help it but prosper as an enterprise or as an investor.

I have highlighted here a few examples of compounding machines. This is not an exhaustive list, as there are a lot more companies to start researching. So here are the examples below:

Exxon-Mobil (XOM)

The company has managed to grow earnings per share from $1.04 in 1993 to $7.37 in 2013. At the same time, the company has managed to increase annual dividends per share from 72 cents in 1993 to $2.46 in 2013. If you invested $1000 in 1993, your investment would be worth almost $10,983 today, and would be earning $300 in annual dividend income.

Johnson & Johnson (JNJ)

The company has managed to grow earnings per share from $0.69 in 1993 to $4.81 in 2013. At the same time, the company has managed to increase annual dividends per share from 25 cents in 1993 to $2.59 in 2013. If you invested $1000 in 1993, your investment would be worth $14,491 today, and would be earning $393 in annual dividend income.

PepsiCo (PEP)

The company has managed to grow earnings per share from $0.98 in 1993 to $4.32 in 2013. At the same time, the company has managed to increase annual dividends per share from 30 cents in 1993 to $2.24 in 2013. If you invested $1000 in 1993, your investment would be worth $7,061 today, and would be earning $210 in annual dividend income.

Many investors refuse to purchase these companies, because they believe that most of the profits have already been made. They believe that there is not much to look forward to for those companies, which is why they keep ignoring them. This is precisely why those investments have done so well for their shareholders – there have always been low expectations for them. As a result, those dividends have been patiently reinvested into more shares at low valuations, resulting in more dividend income, that is then reinvesting into more shares at depressed valuations.. This is a virtuous cycle, that is almost guaranteed to lift the investor fortunes.

Full Disclosure: Long XOM, JNJ, PEP

Relevant Articles:

Six Compounding Machines for Long Term Dividend Investors
How to retire in 10 years with dividend stocks
How to find long term dividend stock ideas
How to become a successful dividend investor
Achieve Financial Independence with Dividend Paying Stocks

4 comments:

  1. Thank you for that great reminder!! Good examples on how we can let our money do the work!

    ReplyDelete
  2. Replies
    1. You can read the analysis of General Mills here: http://www.dividendgrowthinvestor.com/2013/06/general-mills-gis-dividend-stock.html

      DGI

      Delete
  3. So true...Although we just found dividend growth stock investing less than a year ago, we have now fully embraced the concept. In just a short time, we have seen our portfolio and project annual dividends grow. From the consistent and even a few rising dividends, we can already feel the compounding occur. We can only imagine the growth and compounding effect down the road as we add more companies to our portfolio and our yield on cost grows for each holding.

    Cheers to the compounding machines we all call dividend growth stocks! AFFJ

    ReplyDelete

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