When I think about dividend stocks, I normally think about stocks with above average dividend yields. I don't think that's surprising, but I know it's shortsighted. Why? Because a company with a big yield and little dividend growth can be far less desirable to own than, say, Hormel Foods Corp (HRL -0.29%).
Stagnation
If you were looking for a big yield, then Consolidated Communications Holdings Inc (CNSL) might pop up on your short list. This rural telecom currently has a yield of around 8.6%. That's pretty alluring since the S&P 500 only yields around 2% today, but there's a small problem. The company hasn't increased the dividend in over a decade as it has worked to compete with cellphone and cable companies. That means the purchasing power afforded by the dividend has been steadily eroded by inflation, which has historically increased by around 3% per year.
Image source: Getty Images.
So, yes, you are getting a nice yield today. But if you plan to own the stock for a long time and use the dividends to live off of, you might end up disappointed with the outcome. Food manufacturer Hormel, on the other hand, has increased its dividend each and every year for over five decades. And, even more important, the annualized increase over the past decade was more than 15%. That's five times the rate that inflation has typically grown! Which is great, even if Hormel's yield is a measly 2% today.
Let's put some numbers on that so you can get a better picture of how big a deal this really is. Hormel, which owns food brands like SPAM, its namesake Hormel, Jennie-O turkey, and newcomers like Wholly Guacamole, had a dividend of $0.15 a share per year in 2007. By 2016, it was $0.58 per share per year. In just a single decade, Hormel's dividend increased to nearly four times its starting value. Consolidated's dividend sat there, not doing much of anything. And neither did Consolidated stock.
Stock prices and dividends
Here's the thing, Hormel's long string of dividend increases is backed by generally solid earnings results. A company clearly can't keep increasing its dividend for 50 years running if it isn't doing well. The dividend yield, meanwhile, has typically hovered between 1.25% and 2% (it occasionally spikes up toward 2.75%, but that's pretty rare).
As earnings and dividends have trended higher, Hormel's stock has moved higher, too. Over the past decade, Hormel's share price has increased over 290%. But step back to the beginning of this period. At the end of 2007, Hormel's stock was trading hands at around $10 a share (we'll use $10 to make the math simple). Based on the annual per share dividend of $0.15 a decade ago, Hormel's yield was around 1.5%. That's right in line with the historical range and not enough to catch the attention of many dividend investors.
Based on that $10 purchase price, however, Hormel's yield on purchase based on 2016's $0.58 annual dividend per share would have been 5.8%. Now that's a far more interesting number for dividend investors. But all along the way the stock was going up, keeping the yield in that 1.25% to 2% range, so at no point in that run would an investor looking only for high yields have been enticed to buy this hidden gem of a dividend stock.
Now compare that to Consolidated Communications. This high yielder was trading hands at around $18 a share at the end of 2007 with a yield of around 8.6%. A nice dividend stock if you are looking for high yields. It's been a wild ride since that point, but recently the stock has been trading hands at...$18 a share. And since the dividend hasn't budged, the yield is still the same today. Your entire return from owning this stock over the past decade would have been from the dividend, the buying power of which was slowly being eroded by inflation.
Dividend growth matters
The really big takeaway here is that dividend growth matters. If you only look at high yields, you are shortchanging yourself. That said, Hormel's stock is about 20% off of its recent highs. This drop has pushed the yield toward the high end of its historical range. Sure, you could buy Consolidated Communications and its hefty 8.6% yield today, but what about the future? It may not pop up on a screen of high yielders, but Hormel's 2% yield and long history of inflation-beating dividend increases make this food manufacturer an enticing dividend play today.
