True investing wealth is made through compounding. As you reinvest your dividends, interest payments, and sale proceeds into new or additional stakes in great companies, you truly start putting your money to work for you. Once you've had success compounding, the returns on your reinvested capital will provide a huge chunk of your total net worth.
In fact, that's how Warren Buffett transformed Berkshire Hathaway from a struggling textile company into a multibillion-dollar insurance and investment empire. He took the cash thrown off from the company he invested in and parlayed it into further investments, which themselves compounded. And the rest, as they say, is history.
Your compounding engine
Unless you're able to buy out an entire company with your available investing capital, you can't directly replicate Buffett's success. As CEO and essentially controlling shareholder, Buffett commands the cash flows of all of Berkshire's wholly owned subsidiaries. On the other hand, as an ordinary shareholder, the company-generated capital you control is limited to the dividends you receive. Big difference, especially if you don't currently own dividend-paying stocks.
And if you don't own dividend-paying stocks, you should reconsider that decision. Those dividends are the best tool you have available to get compounding to work for you. But the benefits of dividends go beyond the cash you get today. In addition to today's cash, dividends:
- Force discipline on company executives, improving the likelihood that corporate reinvestment of retained earnings will add value to the company
- Provide a tremendously clear signal regarding what those executives really think about their company's prospects
- Can grow over time, helping speed the compounding process
- Help provide stability for your portfolio against daily market volatility
The right dividend payers to own
As wonderful as dividends can be, they won't do you any good if they manage to implode right before your very eyes. Only companies that pay strong and well-supported dividends are worth owning as part of a dividend-focused investment strategy. Ones worth considering are well covered by both reported earnings and operational cash flows and backed by a company with a strong balance sheet, such as these:
|
Company |
Debt-to-Equity Ratio |
Payout Ratio |
Trailing Net Income |
Trailing Cash from Operations |
Dividend Yield |
|---|---|---|---|---|---|
|
PepsiCo |
0.52 |
51.5% |
$5,231 |
$6,744 |
2.9% |
|
Abbot Laboratories |
0.73 |
41.0% |
$5,743 |
$7,025 |
2.9% |
|
United Technologies |
0.56 |
34.8% |
$3,901 |
$5,898 |
2.3% |
|
3M |
0.50 |
50.7% |
$2,794 |
$5,022 |
2.6% |
|
Honeywell International |
0.87 |
40.9% |
$2,162 |
$3,874 |
3.1% |
|
Automatic Data Processing |
0.01 |
48.2% |
$1,340 |
$1,408 |
3.1% |
|
Sysco |
0.79 |
50.4% |
$1,105 |
$1,565 |
3.7% |
With operational cash flows above their net incomes, their businesses all throw off the cold, hard cash needed to support dividends. With a payout ratio below two-thirds of net income, those dividends are well covered by real earnings. And with a debt-to-equity ratio below 1, they're all financially stable enough to be able to support their dividends during a temporary hiccup to their businesses. Put it all together, and you've got a great foundation for strong compounding.
Punch your ticket
Buying companies with solid dividends and then reinvesting those dividends into the same or similar companies along the way is your best chance to put compounding to work for you. At Motley Fool Income Investor, we've seen how powerful a wealth-building tool compounding can be, and we want to help you put it to work for you.
To check out the companies that have already made our cut as being among the best dividend payers around, click here to start your no-obligation 30-day free trial of Income Investor. Once you've seen for yourself just how powerful a tool dividend compounding can be, you can join us as a full member to start using it as lifelong part of your investing strategy.
At the time of publication, Fool contributor Chuck Saletta owned shares of Sysco. Berkshire Hathaway is a Motley Fool Stock Advisor selection. Automatic Data Processing, PepsiCo, and Sysco are Income Investor picks. Berkshire, 3M, and Sysco are Motley Fool Inside Value selections. The Fool owns shares of Berkshire and Sysco and has a disclosure policy.
