All other things equal, of course you'd rather own a stock that offers a steep dividend, instead of one paying a modest one. But all other things are rarely equal, and smaller payouts can pack far more powerful potential for the long haul.
Let me show you what I mean. I found the following stocks while screening for companies with hefty dividend payouts and maximum five-star ratings from our CAPS community of investors:
|
Company |
Dividend Yield |
|---|---|
|
GlaxoSmithKline |
4.8% |
|
Scana |
4.9% |
|
Bristol-Myers Squibb |
4.9% |
Source: Motley Fool CAPS.
Bristol-Myers Squibb may be losing its patent protection for Plavix, but it's also shedding less profitable business lines to focus on drug development. If you're positive on this pharmaceutical's prospects, then its 4.9% yield is just icing on the cake.
But let me add a column to the table:
|
Company |
Dividend Yield |
5-Yr. Avg. Annual Div. Growth Rate |
|---|---|---|
|
GlaxoSmithKline |
4.8% |
5.6% |
|
Scana |
4.9% |
4.7% |
|
Bristol-Myers Squibb |
4.9% |
4.5% |
Source: Motley Fool CAPS.
Those dividend growth rates are solid; they might even beat the raises you've received lately. But you can do better. While you may be inclined to ignore other companies because of their unspectacular yield, a brisk growth rate can help those dividends quickly outpace a heftier initial payout.
Imagine two companies. One pays a 5% yield, increasing that payment by 5% on average each year. The other pays a 3% yield that rises 10% annually. You invest $10,000 in each:
|
Time Frame |
Effective Yield for 5% Stock with 5% Dividend Increases |
Effective Yield on 3% Stock with 10% Dividend Increases |
|---|---|---|
|
Year 0 |
5% |
3% |
|
Year 10 |
8.1% |
7.8% |
|
Year 20 |
13.3% |
20.2% |
|
Year 30 |
21.6% |
52.4% |
Effective yield uses original investment cost as basis for calculation.
See? Within a decade, there's little difference between the two options. And soon after that, the faster grower starts paying you much more. Even if the growth rate slows a bit from 10%, the latter option will likely still outpace the former.
Of course, other factors still matter, too. You still need to make sure you're investing in healthy, growing companies. Just consider looking at their dividend growth rates. Here are some companies from a screen I ran looking for CAPS' top-rated stocks with dividend yields between 2% and 3.5%.
|
Company |
Dividend Yield |
5-Yr. Avg. Annual Div. Growth Rate |
|---|---|---|
|
Sysco |
3.4% |
17.3% |
|
Emerson Electric |
2.8% |
10.9% |
|
Praxair |
2% |
19.7% |
|
Becton, Dickinson |
2.1% |
16.3% |
Source: Motley Fool CAPS.
These are all compelling candidates for your portfolio. Food distributor Sysco dominates its field with powerful economies of scale. Praxair is a leader in industrial gases for a wide range of businesses, and it should see demand pick up as the global economy recovers. Emerson Electric, offering commercial electronics, will likewise benefit; it's already growing its earnings and profit margins. Becton, Dickinson is diversified across the health-care field and sells many frequently replaced supplies, such as syringes.
When it comes to portfolio boosters, it's hard to beat dividends. They can even prop up your holdings during downturns. Look for companies that have been hiking their payouts significantly, and which seem likely to keep expanding their generosity toward shareholders.
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