Wells Fargo (NYSE:WFC) cut its dividend back in March. At the time, it was yielding nearly 10% -- a figure that turned out to be too good to be true.
I didn't own Wells Fargo at the time (and don't today, either), but I can sympathize with shareholders: Recently, lured by a juicy yield, I bought shares of International Paper (NYSE:IP) … not long before the company reduced its dividend by 90%.
Ouch
The lesson? It's not that high yields are risky in and of themselves -- though you should view double-digit yielders with a raised eyebrow.
Rather, the takeaway for me is: Don't chase high yields. Focus on dividend growth instead.
See, here's some good news for you: You can double your dividends, and double the yield you enjoy on the price you paid for your stock -- just by being patient. That's because not only do healthy, growing companies often pay out sizable dividends -- they also tend to increase those dividends over time.
Math trick time
You can use the handy "Rule of 72" to see how long it will take to double your yield. Take 72 and divide it by the expected growth rate. Let's use 12% as a reasonable, generous growth rate (because rates of 20% or 40%, which you'll see sometimes, aren't sustainable over long periods).
Divide 72 by 12 and you get 6 -- telling you that it will take roughly six years to double the dividend. In just 12 years, it will quadruple.
Let's look at some real-life examples:
|
Company |
Dividend Yield |
5-Year Dividend Growth |
|---|---|---|
|
Automatic Data Processing (NASDAQ:ADP) |
3.5% |
18% |
|
Boeing (NYSE:BA) |
3.5% |
19% |
|
PepsiCo (NYSE:PEP) |
3.3% |
21% |
|
AT&T (NYSE:T) |
6.7% |
3% |
|
Verizon (NYSE:VZ) |
6.2% |
3% |
Source: MSN Money.
If we assume that (1) Automatic Data Processing averages dividend growth of just 12% over the coming years and (2) you're earning a 3.5% yield on your cost, then in six years your yield will be some 7%. Six years later it'll be close to 14%. In 20 years, you'll be reaping more than 30% in yield, based on your original purchase price.
If you'd invested $10,000, you'd be raking in more than $3,000 yearly, plus the stock will (hopefully) have appreciated over 20 years. That one-two punch is hard to beat.
Foolish final thoughts
In the table above, AT&T and Verizon are presented as high yielders with slow growth. While these are relatively safe dividend payers, other dividend payouts aren't so sustainable.
Which is why you shouldn't just go out chasing high yields. Also, don't assume that two companies offering 4% yields are largely the same, dividend-wise. For long-term investors, dividend growth matters.
So, where do you find such stocks? If you're looking for a few good dividend stocks, you're in luck. This is a very attractive time in which to buy dividend payers. Companies you may have wanted to own anyway are now offering more attractive prices (with better yields, in some cases) than they were a year or two ago.
Of the names highlighted in the above table, ADP and PepsiCo are two particularly good stocks worth further research. Or if you'd like some help identifying dividend dynamos, we'd love to introduce you to many promising dividend payers via our Income Investor service, which you can try for free. On average, its picks are beating the market handily and boast an average dividend yield of more than 5%. Click here to learn more about a free trial.
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Longtime Fool contributor Selena Maranjian owns shares of PepsiCo. PepsiCo is an Income Investor recommendation. The Motley Fool is Fools writing for Fools.
