Johnson & Johnson (JNJ -0.46%) recently announced it was increasing its dividend for the 61st consecutive year. It's a huge milestone for the business, and the dividend yield is now 2.9%. That's nowhere near 5%, but it could end up getting there. Here's a look at how long it may take for the yield to get to that level and for you to be earning 5% of your original investment back as dividends every year.
The big payoff with dividend growth stocks
If you're investing in a dividend growth stock, one of the big incentives to hold onto it is that you could be collecting much larger dividend payments in the future. There are many high-yielding dividend stocks that can offer investors a higher payout than Johnson & Johnson's stock does, but its more modest payout can be safer, and it's also likely to grow.
Today, it pays a quarterly dividend of $1.19 per share. That is 80% higher than the $0.66 per share that it was paying shareholders every quarter back in 2013, with those increases averaging a compound annual growth rate of 6.1% during that time frame.
That doesn't mean the company will continue to increase its dividend, but if it does, here's how long it would take for you to be earning 5% of your original investment back as dividends -- if Johnson & Johnson were to raise its payouts by at least 5% every year:
Source: Company filings. Chart by author.
If the stock price were to remain unchanged over the years and these dividend increases were to take place, then the dividend yield would climb to around 5% by year 11. However, since Johnson & Johnson's stock is likely to rise in value, it may take longer for the yield to get to that level. Indeed, the dividend yield might never reach 5% if the stock price rises at a faster pace than J&J's dividend payments.
To calculate dividend yield, you take the annual dividend payment and divide it by the stock price. So if a stock does too well and rises at a faster rate than the dividend, the yield will actually come down. On the flip side, if a stock crashes in value, then the yield can instantly shoot up even without the company announcing an increase to the dividend.
Strong earnings make future rate hikes probable
Johnson & Johnson is a business that typically generates strong earnings numbers. Although it has been hit with legal challenges over the years that can sometimes level the company's bottom line, those are not expenses that are recurring in nature. One figure that investors should focus on when assessing a company's profitability is operating income, as that tells you how profitable a business is before any one-time adjustments and nonoperating items potentially distort its net income.
Over the past decade, Johnson & Johnson has consistently generated an operating margin of at least 23%.
JNJ Operating Margin (Annual) data by YCharts.
The healthcare company's strong financials enable Johnson & Johnson to continue making increases to its dividend. Last year, the company's free cash flow totaled $17.2 billion -- 47% higher than the amount it paid out in dividends. Although increases to the dividend are by no means a guarantee, Johnson & Johnson is certainly among the safest dividend growth stocks on the market, given its impressive financials.
Should you buy Johnson & Johnson stock for its dividend?
Johnson & Johnson is an ideal stock if you want an investment to just buy and hold. Although it has endured legal trouble in the past and the talc lawsuits it needs to deal with are a cloud over the business today, due to its strong profits and continued growth, it's not an overly risky stock to be holding.
The investors who will benefit most from owning the stock are those who are willing to hold it for years and get the benefit of the growing dividend. As long as Johnson & Johnson's business continues on its path and generates strong earnings numbers, investors should eventually be collecting at least 5% of their original investment back as dividends. And that's what makes this a great dividend stock to be holding as investors get a relatively safe investment that can also generate an increasing level of dividend income over time.
