How You Can Enjoy a 25% Dividend Yield

Every now and then I write about "effective" dividend yields, such as in this piece about how my dividend yields are bigger than other people's. I occasionally hear from some readers who grumble that I'm wrong to pay any attention to such numbers, and that the current yield is all that matters.

I'll back up a bit, explain the situation, and argue against them.

For starters, let's review the dividend yield in general. To arrive at it, you simply take the amount a company pays out in dividends each year (usually in quarterly installments) and divide it by the company's current stock price. For example, Colgate-Palmolive (NYSE: CL  ) is paying $1.76 per year in dividends ($0.44 per quarter), and last week, it was trading around $59. Divide $1.76 by $59 and you get roughly 0.03, or a current dividend yield of around 3%.

So if you buy some shares of Colgate-Palmolive today, you'll enjoy a 3% dividend yield -- the company will essentially pay you 3% of your purchase price, per year.

Things change ...
The investing world isn't a static one, though. Over time, the price of the stock will change, going up and down from day to day. Over years, it likely will go up, if the company remains healthy and growing. The dividend, too, likely will increase. Healthy companies tend to hike their dividends relatively regularly. Over the past 20 years, for example, Colgate-Palmolive has averaged about 12% annual growth for its dividend.

Let's say that the dividend grows by 10%, per year, over the coming 20 years. And let's say also that the stock price grows at the same rate (which happens to be the average historic annual growth rate for the entire stock market, over many decades). Here's what you would see:

Year 

Stock price  

Dividend  

Div. yield that year

2009

$59.00

$1.76

3.0%

2010

$64.90

$1.94

3.0%

2015

$104.50

$3.12

3.0%

2020

$168.33

$5.02

3.0%

2025

$271.10

$8.09

3.0%

2029

$396.92

$11.84

3.0%

See anything interesting? That's right -- the dividend yield stayed the same! For anyone buying the stock in each of those years, they would receive 3% of their purchase price in dividends in that year.

Meet the effective yield
Here's the point I want to make, though. Remember that in our example, you bought your shares in 2009, at $59. You received $1.76 in that first year, your 3% yield. If you were still holding your shares in 2020, though, you'd be receiving $5.02 for the year in dividends. Divide that by your purchase price of $59 (instead of the then-price of $168.33), and you'll get an effective yield, a yield on cost, of 8.5% -- almost three times the then-current yield.

By 2029, after 20 years of holding the stock, your effective yield would be 20%. Five years later, it would be 32%! What you're looking at right now is the amazing power of dividend growth.

What to do
So go ahead and look for some significant dividend payers for your portfolio. In this market, they're much more plentiful than usual. Also, be sure to pay attention to the companies' dividend growth rates, because a rapidly growing dividend can give you a steep yield on cost in a number of years.

Here's a sample of some large-cap stocks with yields of at least 3% and dividend growth rates of at least 10% per year over the past five years:

Company

Recent yield

5-year dividend growth rate

Novartis (NYSE: NVS  )

4.6%

14%

Kraft Foods (NYSE: KFT  )

5.0%

12%

Reynolds American (NYSE: RAI  )

8.9%

14%

Paychex (Nasdaq: PAYX  )

4.5%

23%

SYSCO (NYSE: SYY  )

4.2%

13%

Illinois Tool Works (NYSE: ITW  )

3.8%

20%

Source: MSN Money.

That's not a rush-out-and-buy list, but instead a list for further study. Click over to our CAPS community of investors to learn more. (All of the above recently earned four or five stars in CAPS.)

A free, no-obligation trial of our Income Investor service will give you dozens of researched recommendations, many yielding 8% or more.

Longtime Fool contributor Selena Maranjian owns shares of Novartis and Paychex. Novartis is a Motley Fool Global Gains recommendation. Kraft Foods, Paychex, and SYSCO are Income Investor recommendations. Paychex is an Inside Value recommendation. Try our investing newsletters free for 30 days. The Motley Fool is Fools writing for Fools.


Read/Post Comments (7) | Recommend This Article (13)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 06, 2009, at 1:15 PM, jpanspac wrote:

    I agree with the naysayers. Re-interpreting the dividend yield this way is misleading at best. And I'm getting pretty tired of these misleading headlines that end up wasting my time,

  • Report this Comment On April 06, 2009, at 1:27 PM, pondee619 wrote:

    "...I'm getting pretty tired of these misleading headlines ..."

    Let's fix the Headline so it is no longer misleading-

    How You Can Enjoy a 25% Dividend Yield in Twenty Years +/-

    But, you see, the headlines are not meant to be descriptive of the articles that follow. The headlines are meant to get you to read the artilce, be so impressed that you will buy the news letter hyped by said article. To wit:

    "A free, no-obligation trial of our Income Investor service will give you dozens of researched recommendations, many yielding 8% or more", provided that you give us your credit card number now.

  • Report this Comment On April 06, 2009, at 1:29 PM, BMFPitt wrote:

    I agree, that's just fuzzy accounting...

    Especially if you aren't accounting for inflation.

  • Report this Comment On April 06, 2009, at 2:37 PM, vapoly01 wrote:

    Actually...it makes sense and shows why dividend investing is the way to go in the long haul.

    It might have been better demonstrated by looking backwards as well. For example, shares of CL purchased in 1999 are currently yielding 4%. And that doesn't even consider dividend reinvestments.

    Seems pretty clear to me.

    But hey, go ahead...naysay and speculate

  • Report this Comment On April 07, 2009, at 11:59 PM, jbacpa wrote:

    This one isn't hypothetical, it's actual. In early January of 1981, when I was fairly early in my asset accumulation phase, I bought SYY for pennies under $30 per share. As I recall, it paid about a 1% dividend, but I didn't pay that much attention to it because I had bought the stock for growth. Even after the recent price crater, since the purchase date, the average annual compound price appreciation is about 14.65%. I'm now retired and in my coupon-clipping years. I still hold most of the SYY that I bought back then. Since my purchase, the stock has split 2:1 six times, so my split-adjusted basis is $0.462 per share. The current dividend of $0.96 per share is 207.8% of my original cost. I hope all you geniuses do as well some day.

  • Report this Comment On April 09, 2009, at 4:37 PM, timslearning wrote:

    The easiest way to get 25% dividend yields is to buy Georgia Gulf Coast GGC the dividends are already over 25%. NO JOKE

  • Report this Comment On April 18, 2009, at 5:22 PM, vgaymer wrote:

    ^^

    Jerry,

    I took a look at that list, and I'm not sure how div yield is calculated, but it looks like it's just taking the last dividend payment divided by share price at least for DOW components.

    A lot of foreign companies only pay semi annualy or annualy which I'm guessing is why this list is skewed towards them.

    Hope this helps,

    G

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