What's the best way to pick a dividend stock?
There are several approaches, and the best one for you will depend on your investing needs and risk profile. Most investors tend to evaluate the dividend yield first: the annual dividend divided by the share price. In today's market, with dividend payers in the S&P 500 averaging a yield of 1.9%, even a yield above 4% will catch the dividend investor's eye.
Dividend growth is also worth considering. While some Dividend Aristocrats -- stocks that have raised their payouts annually for at least 25 years in a row -- offer attractive yields and have solid track records, their growth rate may just be in the low single digits, which can be a problem for long-term investors. That's why it's important to consider the both growth rate and dividend payout ratio.
Finally, there are special situations like Costco Wholesale, which just offered a $7-a-share special dividend, its third such payout since 2012.
But long-term investors who are saving for retirement, a child's college fund, or even to pass assets down to their descendants will want to consider dividend growth above all else. Below are two rock-solid companies with fast-growing payouts that are likely to be dividend powerhouses decades from now.
1. Starbucks Corp.
In the span of one generation, Starbucks (SBUX 2.77%) has gone from a small coffee chain to the second-biggest restaurant company in the world, behind McDonald's. Plenty of jokes have been made over the years about the company's ubiquity, but it continues to expand aggressively, adding more than 2,000 stores last year to top 25,000 worldwide.
Starbucks began paying a dividend in 2010, and has raised it by more than 20% each year since. During that time, the quarterly dividend has quintupled on a split-adjusted basis, rising from $0.10 to $0.25. (Shares split 2:1 in Q2 2015.) Today, the coffee chain offers a yield of 1.6%. As the chart below shows, earnings have mostly kept pace with the dividend payout, a good sign for its future dividend growth.
With a payout ratio of 51%, Starbucks still has considerable room to raise its dividend without an equivalent increase an earnings, but the dividend growth rates is likely to slip below 20% in a few years. Still, the long-term growth opportunities for the company in China, brand premiumization through the Reserve stores, and areas like mobile ordering and delivery should continue driving growth for Starbucks, and funding dividend increases at least above 10%. Most Dividend Aristocrats, by comparison, offer dividend growth in just the single-digit percentages.
2. Nike Inc.
Like Starbucks, Nike(NKE 2.12%) dominates its industry, and has crushed the market over the long term. With its brand and distribution advantages, and its leadership in athletic footwear, Nike is likely to continue to outperform the market.
The Air Jordan-maker has been paying a dividend since the 1980s and has raised its payout every year since 2004, with increases of 12.5% or more since the Great Recession. At 1.3%, the yield today is relatively meager, but Nike has more than made up for it in earnings growth. As the chart below shows, over the last five years, the dividend payout and EPS growth have kept pace with each other, as both have doubled.
Nike has historically kept its payout ratio low; it's currently around 30%. I'd expect the company to maintain it at that level as it invests in R&D and expansion. That means that its yield will remain modest, but as earnings grow, so will the dividend, and the company should be able to continue its pattern of double-digit percentage increases.
Both Starbucks and Nike have set bold revenue targets. Starbucks appears to be well on its way to hitting its goal of $30 billion in revenue in 2020, and predicts EPS growth in the range of 15% to 20% over the next five years. Nike, meanwhile, is eyeing $50 billion in revenue by 2020 with EPS growth in the mid-teens. Both companies have knocked down such goals in the past, and should be able to do so again. As they continue to grow, those dividend increases will set up long-term investors to reap handsome rewards.