Please ensure Javascript is enabled for purposes of website accessibility

The Most Important Dividend Stock Chart You'll Ever See

By Matthew Frankel, CFP® - May 28, 2016 at 7:41AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Here's why you should focus on high-quality dividend growth stocks, no matter how old you are.

What's the most important thing to consider when choosing a dividend stock? If you think it's the current dividend yield, you're wrong. While a high yield is definitely nice to have, especially if you rely on your stocks for income, the most important thing to look for is a stock's potential for high total returns, which could mean millions of dollars for your portfolio over time.

What is total return?

A high dividend yield is nice, but doesn't necessarily make a dividend stock a great investment. It's far better to have a consistently growing dividend as well as potential for the stock itself to appreciate over time.

The combination of dividends and price appreciation is known as total return. For example, if a stock's price rises by 5% this year, and it pays a 3% dividend, it's total return would be 8%. As we'll see shortly, this is how dividend investors get rich over time.

The power of compounding

There are two main types of interest, or returns, in investing: simple and compound. Simple interest refers to the same rate of return each year. Bonds are an example of an investment that pays a simple rate of return. If a $1,000 bond has a 6% coupon interest rate, you'll get $60 per year for the life of the bond -- no more, no less.

On the other hand, compound interest can be a dividend investor's best friend. In a nutshell, compound interest means interest is paid on the principal as well as the interest already accumulated.

For example, let's say you own $10,000 of a stock that pays a 5% dividend. By choosing to reinvest your dividends in additional shares of the same stock, you can take advantage of compounding. The first year, the stock will pay you $500 in dividends, which you use to purchase additional shares. Now your investment is worth $10,500, and your next 5% dividend will be worth $525, bringing your investment's value to $11,025.

The point is that every year, your dividend will get bigger. In fact, after 20 years, your dividend payment would grow to $1,263 -- and that assumes the dividend itself doesn't grow. Once that variable and an increasing share price are factored in, you might be surprised at what can happen.

Compound total returns can make you rich

To illustrate the amazing power of compound total returns, I'll use one of my favorite dividend stocks as an example -- healthcare real estate investment trust Welltower (WELL 1.04%).

Welltower has been a publicly traded company for approximately 45 years, and during that time, the company has increased its dividend consistently at an average annual rate of 5.7% thanks to ever-increasing income from its portfolio of properties. Also, because real estate tends to appreciate in value over time, the share price has risen substantially as well. In fact, between dividends and the share price, Welltower has produced an average 15.6% total return since its inception.

Data source: Welltower company presentation. 

Here's where it gets fun. Let's say  an investor bought $10,000 of Welltower stock 45 years ago and reinvested all of the dividends she received over the years. How much would her investment be worth today? $500,000? A million dollars, maybe? Actually, this investment would have ballooned to $6.8 million thanks to compounding. Imagine if this investor didn't stop with the initial $10,000 investment and had added to it over time -- we could be talking about a return well into the eight-figure range.

Now, keep in mind that if you had actually made this investment, the performance wouldn't have been nearly as steady as the line in this chart. Like any other stock, Welltower has experienced its ups and downs over the years. However, as long-term investors, we're far less interested in a stock's performance in any short time period than we are in its potential to deliver market-beating performance over time.

As a final point, dividend reinvestment doesn't need to cost you a dime. Most stocks can be enrolled in a dividend reinvestment plan (DRIP) either through your brokerage or directly through the company. When enrolled, any dividends you receive will be used to buy additional shares, even if the purchase results in fractional shares. If you get a $60 dividend payment and the stock is trading for $40, you'll get 1.5 shares added to your account -- and without any commission whatsoever. For these reasons, it's important to do this with every dividend stock you own.

Invest early and often, and let your dividends ride

The main takeaway is that time is a dividend investor's greatest ally. Since the power of compound returns increases over longer periods of time, now is the most critical time to get started. So, pick your high-quality dividend stocks, be sure to enroll them in a DRIP through your brokerage, and start investing as soon as you can. If you do that, you'll see firsthand just how powerful those seemingly small dividends can be.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Welltower Inc. Stock Quote
Welltower Inc.
$83.21 (1.04%) $0.86

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/02/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.