For the investor with a long time horizon, the combination of growth and income can be a beautiful thing. The trouble is, we hear too much about growth and not enough about income.
The fact is that both are equally important, though you'll be hard-pressed to find headlines in The Wall Street Journal or CNBC highlighting the fact that Kellogg's (NYSE: K ) income return made up 42 percentage points of the stock's 123% total return over the past decade.
That's right: Over the past decade, the slow-and-steady dividend returns have accounted for just over a third of the stock's total return.
Both growth and income played important roles in delivering Kellogg's market-beating performance, so it's certainly worth considering a stock's income stream in addition to its growth potential before investing.
Good things come in small checks
A steady and ideally rising income stream from stocks matters quite a bit to your long-term returns because dividends not only provide periodic real returns, but they can also be reinvested to buy more shares and augment your overall return. Consider the case of Johnson & Johnson (NYSE: JNJ ) , which over the past five years has been afflicted by, among other things, the credit crisis, U.S. health-care reform, and some damaging product recalls.
Had you purchased the stock in September 2006 for $64.67 and simply took the dividends as cash, you'd still be facing a negative capital return five years later, as the stock price is currently $61.59. However, if you had instead reinvested the quarterly dividends, you'd be up about 14% because you would have picked up more shares on the cheap along the way and lowered your average cost per share.
That's the beauty of reinvesting dividends: They force you to invest more without having to think about it.
To find stocks that can deliver both growth and income, I used the following screen:
- Return on equity greater than 15%: We want our companies to earn market-beating rates of return on their equity.
- Sufficient free cash flow cover (less than 60%): It's important that our companies generate enough free cash flow (cash from operations minus capital expenditures) to cover their dividend payouts and increase them down the road.
- Dividend yield over 2.5%: With the S&P average yield currently around 2.2%, we want to generate enough income to make it worth our while.
- Debt-to-equity ratio below 50%: We want to identify companies with strong balance sheets.
Here are five stocks that meet the criteria for growth and income:
|
Company
|
Return on Equity
|
Free Cash Flow
Payout Ratio
|
Dividend Yield
|
Debt-to-Equity Ratio
|
| Novartis (NYSE: NVS ) |
16.5% |
48% |
4.5% |
41% |
| Intel (Nasdaq: INTC ) |
25.9% |
43% |
3.8% |
5% |
| Walgreen (NYSE: WAG ) |
16% |
19% |
2.6% |
16% |
| Emerson Electric (NYSE: EMR ) |
23.3% |
40% |
3.3% |
47% |
| ExxonMobil (NYSE: XOM ) |
25.3% |
35% |
2.7% |
10% |
Data provided by Capital IQ, a division of Standard & Poor's, as of Sept. 26, 2011.
Put the cash to work
Whatever your risk tolerance or time horizon, don't underestimate the importance of income returns for your portfolio. Indeed, dividend stocks can end up being the most unlikely growth stocks you'll ever own because, among other things, dividend payouts force managers to allocate capital more efficiently, delivering superior and more sustainable returns for shareholders.
If you're looking for more dividend stock ideas, a team of Foolish analysts have put together a report containing 13 high-yield dividend stocks to buy in today's market. One of these 13 stocks is mentioned in the table above and was called a "dividend stock for the next 50 years." If you'd like to receive this free report, simply click here.
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