Do you want to collect 10% of your investment back in dividends? There are stocks that yield that much right now, but there's often a significant risk with seeking out those types of investments. Generally, stocks with such high yields either have unsustainable payout ratios or their shares have been crashing heavily, perhaps because their underlying business is in trouble.
That's why if your goal is to lock in a 10% yield right now, it could be a risky strategy. A safer approach is to invest in dividend growth stocks. Over time, their increases will accumulate, and your recurring dividend income will rise.
A top dividend growth stock to consider
When investing in a dividend stock, it's important to look at one that has been increasing its payouts over time. That doesn't necessarily guarantee that it will continue to make dividend hikes in the future, but it's a great indication that the company's management is willing to do so. Plus, it also suggests the business' fundamentals are strong enough to support such moves.
A dividend growth stock that could make earning 10% back in dividends a reality is healthcare company and top drugmaker AbbVie (ABBV -1.10%). Today, it pays a yield of 3.7%. That's not bad, and at that rate, you would need to invest just over $27,000 to be earning $1,000 in annual dividend income.
But over the years, AbbVie has been increasing its payouts. Its current quarterly dividend payment is $1.41, which is 8.5% higher than the $1.30 it was paying a year earlier. And compared to five years earlier, when it was paying $0.64 every quarter, the dividend has risen by 120%, averaging a compound annual growth rate (CAGR) of 17%.
This tells investors that the company's recent round of increases has been slower than it was in the past. That can be common as businesses expand and choose to deploy more cash on growth objectives rather than dividends. And with the drugmaker's top-selling drug, Humira, facing patent expiration next year, AbbVie definitely has plenty of incentive to work on strengthening its business however it can before that happens. That could mean a slower dividend growth rate in the future, which, in turn, will impact how quickly your dividend income rises.
How long would it take for the dividend to be 10% of your investment?
The key to forecasting how long it will take for your dividend income to grow to the desired goal is estimating the dividend growth rate. If you're earning $37 on every $1,000 invested in the company today (i.e., a 3.7% yield), then a 10% dividend would be $100. That means the dividend would need to increase by 170% from where it is now.
At the five-year CAGR of 17% that AbbVie's dividend has been averaging, it would take more than six years of increases to get to that level. A more conservative estimate would be using 8.5%, the rate of its most recent increase. Under that assumption, you're looking at around 12 years of growth for $37 in dividend income to turn into $100. And if you wanted to be even more conservative and assume AbbVie slows its rate hikes further, to say an average of 5%, then the number of years you may need to wait is 20.
It can be difficult to estimate the growth rate, especially when you're looking at such a long time frame. The longer the period, the less likely it is that a high growth rate will be sustainable. But the conclusion remains the same: Buying and holding shares of a top dividend growth stock can be a way to significantly increase your recurring income from the stock and a way to collect 10% or more of your initial investment back through dividends.