Last week, I started taking a look at exactly where investors should be looking for dividend stocks. I started by slicing and dicing the S&P 500 to figure out where various types of dividend stocks are hiding out in that index. I then moved on to putting high yielders under the microscope to figure out whether investors should give in to the siren song of fat dividends.
At the risk of spoiling the surprise for those who haven't been following along, high-yield stocks have actually performed quite well in the past -- at least when it comes to overall investor returns. However, when it came to dividend growth, I found that many high-yielding stocks ended up seeing more dividend cuts than gains.
Do the dividends of stocks with lower yields but higher dividend growth rates avoid a similar fate? I figured I'd have to dig in to find out.
Bigger dividends ahead
To take a closer look at what we might be able to expect from companies that have cranked up dividend growth, I looked back to the year 2000. Specifically, I took the 500 largest companies that had a dividend payout ratio of 10% or more for 1999, and then grabbed the 25 that had the fastest dividend growth over the preceding three years.
Here are some averages I found for the 25 companies selected:
Dividend Yield,
|
Annualized Dividend Growth,
|
1-Year Dividend
|
Dividend Growth from 1999
|
Dividend-Adjusted
|
---|---|---|---|---|
2.2% |
37.5% |
17.5% |
179.0% |
108.6% |
Source: Capital IQ, a Standard & Poor's company, Yahoo! Finance, and author's calculations.
The stocks in this group had a much lower starting yield than the high yielders that I looked at last week, but those dividends fared much better than those of the high yielders. While this group grew dividends by nearly 180% between 1999 and today, the other group saw dividends shrink by 25% on average.
It's worth noting, though, that the growth average was to some extent a do-or-die mix of companies that either grew their payout like crazy or drastically slashed it. Federated Investors, for instance, cranked up its dividend by 781% since 1999, while Citigroup
Let's not lose sight of the bottom line here, though -- the 109% average gain for the group significantly outpaced the S&P's dismal 23% loss. Of course, if we want to continue our comparison, that 109% doesn't stack up too well against the high yielders' average return of 212%. And while 84% of the high yielders topped the S&P, "only" 72% of the high growers did the same.
To beef up my results just a bit, I ran through the same exercise in 2005:
Dividend Yield,
|
Annualized Dividend Growth,
|
1-Year Dividend
|
Dividend Growth from 2004
|
Dividend-Adjusted
|
---|---|---|---|---|
3.3% |
111.3% |
18.8% |
101.1% |
77.8% |
Source: Capital IQ, a Standard & Poor's company, Yahoo! Finance, and author's calculations.
The comparison between the high growers and high yielders is pretty similar over this period as well. Once again, the growers tended to keep growing their payout, while the high yielders were more likely to cut their payout. The returns of the two groups over this stretch were pretty similar, though the high yielders showed more consistency -- 80% of the high yielders beat the S&P 500, while only 56% of the high growers did.
Bag some dividend growth
I have to admit that based on the data I looked at I wasn't as impressed with the dividend growers as I was with the high yielders. However, the growers did, on average, produce market-beating results and there were some serious rocket-shots in that group -- Novo Nordisk was up more than eight-fold, while Kinder Morgan Energy Partners
In other words, it's probably worth having our eye on this group as well. So with that in mind, here are the current top 10 dividend growers. As before, these are from a list of the current 500 largest U.S.-listed companies and they all had a payout ratio of 10% or more over the past 12 months.
Company |
Yield |
Annualized 3-Year
|
Payout Ratio |
---|---|---|---|
Wimm-Bill-Dann Foods |
1.2% |
292% |
33% |
Vivo Participacoes |
4.5% |
205% |
76% |
Shaw Communications |
4.0% |
165% |
69% |
Western Union |
1.4% |
162% |
15% |
CenturyLink |
7.5% |
124% |
85% |
Broadridge Financial |
2.6% |
111% |
35% |
Companhia Brasileira de Distribuicao |
1.0% |
88% |
28% |
Rogers Communications |
3.3% |
81% |
45% |
CMS Energy |
4.7% |
77% |
55% |
Pharmaceutical Product Development |
2.4% |
73% |
75% |
Source: Capital IQ, a Standard & Poor's company.
The question, of course, is how to try and fish out the companies from this list that have the best chance of both growing their dividends and delivering overall market-beating returns.
My initial reaction might be to assume that the companies with higher payout ratios will have a more difficult time growing their dividends and may struggle to provide investors with hefty returns. But the data doesn't necessarily line up -- Citigroup, for example, had a sub-20% payout ratio in 1999 and has performed dismally, while Kinder Morgan's high payout ratio at the time hasn't stopped it from putting up huge returns.
The trick, then, is to look for companies with strong business fundamentals, good cash flow generation, and maybe also a low payout ratio. From the list above, I think Western Union, Broadridge Financial, and Pharmaceutical Product Development could all fit in that category -- though PPD's payout ratio is definitely on the higher end.
On the other hand, I'm a bit less sanguine on companies like CenturyLink and CMS Energy. CenturyLink operates in an industry that is largely moving in the wrong direction and is about to embark on the integration of the sizable acquisition of Qwest. CMS, meanwhile, is a utility that has seen hefty dividend growth only because it had discontinued its dividend for a number of years. It seems unlikely that CMS' rapid payout growth will continue.
Which one of these stocks do you think will produce market-smashing returns over the next decade? Head down to the comments section and share your thoughts.
One of the companies here hit my radar as a dangerous stock to beware of. See which it is.