These Stocks Are in the Sweet Spot

Tortoise or hare?

When someone mentions a dividend-paying stock, which image first comes to mind? I'd imagine that you and 99% of the rest of the investing public would say "tortoise." Dividend payers are slow-growing entities, right?

After all, finance theory says that one of the main reasons a company pays a dividend is because it doesn't have enough profitable investment opportunities within its business, and therefore chooses to distribute a chunk of its profits to owners.

Faster-growing companies have many profitable opportunities to deploy profits, and therefore feel they can best serve shareholders' interests by reinvesting the cash in their business.

But hold that thought...
A dividend indicates that the company is confident enough in its future growth to pay out a fixed portion of its earnings every year. High-growth companies may promise more growth, but their position could be riskier as they head into uncharted waters.

Could dividend payers actually grow faster over time, tortoise-style, while hare-like growth stocks falter along the way?

To answer that question, I decided to look at some empirical evidence. I searched the Capital IQ database for the trailing-10-year earnings growth rates of dividend-paying companies with a $1 billion or greater market cap. I used 10% compounded earnings growth rate as the hurdle, and compared those results with the growth rates of non-dividend-paying companies also capitalized at greater than $1 billion.

Should be an easy victory for the non-dividend payers, right?

Defying conventional wisdom
Not so! The results of the search defy accepted wisdom. Fully 20% of 981 dividend-paying companies were able to increase earnings at a 10% annual rate over the past 10 years, while only 15% of 583 non-dividend payers could do the same.

What's more, last year my colleague James Early cited a study that confirms my findings:

In 2003, Rob Arnott -- former editor of the Financial Analysts Journal, a publication of the CFA Institute -- and Clifford Asness, managing principal at AQR Capital Management, looked at dividend yields and subsequent 10-year earnings growth. Their findings? Amazingly, earnings growth increased with dividend payout, right up to the highest payers having the highest next-10-year earnings growth.

This tells us two things:

1. It's pretty hard to generate consistent earnings growth over time (in my Capital IQ research, only 15%-20% of companies could), and
2. Dividend payers are more likely to do so.

Pretty revolutionary, no? The stodgy, supposedly slower-growth companies actually grew faster than their supposedly high-growth rivals. Admittedly, the tech bubble collapse may have played a part in these results, but the underlying message is that dividend payers can grow at not-so-shabby rates over time.

This spurred me to seek out stocks with a decent dividend yield and a recent history of strong growth. I also wanted well-capitalized companies, so I set the long-term debt-to-equity ratio below 75%. The handy CAPS screener returned the following seven companies.

*Out of five stars.

Wow. These companies' average revenue growth was 23% over the past three years, yet they're yielding an average of 7%. Obviously, their future growth profile might differ from their past performance, but these seven stocks seem to live in that sweet spot: solid growth and a decent dividend. Thus, these fast-growing dividend payers are a good place to start your research.

If the winning combination of growth and dividends has you intrigued, check out our Motley Fool Income Investor newsletter. Since its inception in September 2003, its picks have returned 16%, vs. 8.5% for the S&P 500. Come sample the service, and see our team's top five dividend stocks for new money, with an absolutely free 30-day trial -- just click here for all the info.

Fool analyst Andrew Sullivan loves dividends, but he does not have a financial position in any of the stocks mentioned in this article. AllianceBernstein is a Motley Fool Income Investor recommendation. Telekom Indonesia is an Income Investor and Global Gains selection. The Motley Fool has a disclosure policy.