Stock investors always like to see growth. Yet, while most growth investors focus on earnings, you can see another positive sign of a great stock by looking at how its dividends grow over time.
An arbitrary distinction
Interestingly, many investors think of dividend investing and growth investing as two completely different strategies that are almost mutually exclusive. That's because many growth stocks that are still in the early stages of their development don't pay any dividends, since they need any money they can make to plow back into their businesses. In fact, some investors would likely conclude that a growth stock that started paying a dividend must be nearly the end of its high-growth phase, given the implication that the company didn't have any better use for the cash than to return it to shareholders.
In contrast, many see traditional dividend stocks as conservative, boring companies that have no more growth prospects. Their mature businesses generate strong cash flow, but they don't have enough potential to justify reinvesting cash back into them, and so corporate managers simply pay it out as dividends.
But just because a stock pays a dividend doesn't mean that its growth days are automatically over. In fact, if you asked a dividend investor what they'd like to see in their ideal stock, they'd probably say that steady, sustainable earnings growth was just as important as a steadily growing dividend payout.
Two ways to grow that go well together
As it happens, a number of dividend stocks have exactly that combination of solid earnings and substantial dividend growth. Here's a small sample:
|
Stock |
Dividend Yield |
5-Year Earnings Growth Rate |
5-Year Dividend Growth Rate |
Payout Ratio |
|---|---|---|---|---|
|
Monsanto |
1.3% |
135% |
47% |
25% |
|
McDonald's |
3.5% |
22% |
36% |
50% |
|
Microsoft |
2.1% |
17% |
27% |
31% |
|
Lockheed Martin |
3.0% |
24% |
22% |
36% |
|
CSX |
1.9% |
62% |
35% |
30% |
|
IBM |
1.8% |
16% |
25% |
22% |
Source: Capital IQ, a division of Standard and Poor's. Growth rates are annualized.
The first thing you'll probably notice about this list is that some of the stocks aren't the high-paying dividend stocks you're used to seeing from a dividend screen. Given that the average yield for the S&P 500 is nearly 2.5%, many of the stocks above seem to skimp on their payouts in comparison.
What they do have, though, is a stronger history of growth. More traditional dividend companies like Kimberly-Clark
In particular, stocks like Monsanto and CSX, which have grown their earnings much more quickly than they've raised their dividends, give dividend investors a lot of hope in the coming years. Although their current dividend yields are relatively low, growing earnings should lead to greater cash flow, some of which will likely go toward increasing their payouts. And even as their growth rates inevitably slow down, their low payout ratios ensure that the companies have plenty of latitude to raise dividends well into the future.
On the other hand, some of the more conservative stocks on the list have already seen their fast-growth phase end, yet they've still been able to post solid earnings growth in the past five years. Although a faster dividend growth rate means that these companies can expect to see their payout ratios creep upward over time, their current low levels mean that investors shouldn't need to worry about dividend cuts anytime in the near future.
Break the mold
When you're looking for investment ideas, it often makes sense to think outside the box. Rather than falling into old patterns of seeing stocks as growth stocks or dividend stocks, look for all of the attractive qualities that you'd like to see in an investment. Going beyond the traditional definitions can help open the door to great stocks you've never thought about before.
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