Demand Dedicated Dividends

Recently, seekingalpha.com's Tyler McKinna penned an intriguing article singing the praises of dividend growth investing -- an approach I can hardly dispute.

McKinna offered an eye-opening example of the power of dividend growth. An investor who bought $500 worth of stock in Anheuser-Busch (NYSE: BUD  ) in 1980, reinvesting the dividends in additional shares of stock, now receives more each year in dividends than he paid for his initial stake in the company. 

I've offered similar examples describing a reader's successful long-term investments in Wells Fargo (NYSE: WFC  ) and General Electric (NYSE: GE  ) .

Better than annuities
Dividend growers are useful partly because they help you counteract inflation. When you buy into various investments, some offer inflation protection, promising to increase your ultimate payout to keep in step with inflation. Many other investments, such as traditional bonds and some fixed annuities, offer no inflation protection at all. But solid dividend-paying companies tend to increase their payouts each year, typically by more than the rate of inflation.

Inflation over the past several decades has averaged between 3% and 4% per year, at most. Take a gander at the kinds of five-year dividend growth rates you can get with many companies (per Morningstar.com):

Company

5-year dividend growth rate

Estee Lauder (NYSE: EL  )

20%

W. W. Grainger (NYSE: GWW  )

13%

Masco (NYSE: MAS  )

11%

Sherwin-Williams (NYSE: SHW  )

16%

Of course, dividend growth takes time. But eventually, the power of compounding helps turn modest payouts into exceptional ones. And meanwhile, you get a nice reward right now, with current yields that top 4% or even 5%. Our Motley Fool Income Investor newsletter, for example, sports more than 25 recommendations with yields above 6%.

If you invest $10,000 in a stock with a 5% yield, you'll be collecting $500 each year from the get-go. If that dividend grows by an annual average of 10%, you'll be collecting nearly $1,300 yearly within 10 years. After 25 years, your dividends will yield more than $5,400 annually. Divide $50,000 into five stocks with 5% yields today, and you'll already be collecting $2,500 annually. Patience will reward you more, but from the outset, you'll be beating many CDs and other alternatives.

A little advice
If you're interested in using dividend stocks to grow your portfolio, here are a few things to bear in mind:

  • Many brokers allow you to automatically reinvest your dividends. Without that feature, you'd often have to pay a big part of your quarterly payment on broker commissions.
  • Even if you use your dividend payments to buy additional shares of stock, you'll still get taxed on them, just as you would if you took the cash. So don't leave yourself without enough money to cover your tax liability.
  • Just because a stock has a high dividend doesn't mean that it's a great investment. Often, stocks that have the highest dividend yields available have potential problems. If those problems get bad enough, you could find yourself taking a double hit, as the dividend and the company's shares both decline.
  • The bottom line to remember here is that dividend growth can be a very powerful factor in your portfolio. Just approach it sensibly: Look for healthy, growing companies with briskly expanding dividends.

Longtime Fool contributor Selena Maranjian owns shares of General Electric. Masco is a Motley Fool Income Investor selection. Anheuser-Busch is a Motley Fool Inside Value pick. Sherwin-Williams is a Motley Fool Stock Advisor recommendation. Try any of our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.


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