As the stock market has flattened out in recent months, investors are increasingly recognizing the value of dividend-paying stocks in building wealth. Yet while many investors gravitate toward the highest-yielding stocks they can get right now, thinking past immediate payouts from your dividend stocks may well pay even greater rewards in the long run.
Now and later
Different investors have different reasons for including dividend stocks in their portfolio. For those who need income for living expenses right now, such as current retirees, the big payouts that high-yielding dividend stocks provide can make the difference between staying afloat rather than not paying all your bills. Especially when other income-producing investments haven't been pulling their weight, dividends can make or break your finances.
For those with longer time horizons, though, there's another attribute that's arguably even more important than a stock's current yield: whether the company has been able to grow its payout over time. After all, a healthy payout right now isn't worth much if it's just going to go away in a few years. You might be better off picking stocks with more modest dividend yields if they're poised to grow substantially over time.
To see some examples of how this might work, I took a look at the top stocks in the S&P 500 in terms of having grown their dividends over the past 10 years. Here were the results, along with their 10-year average annual returns:
|
Stock |
Current Yield |
Average Annual Dividend Growth Rate Since 2000 |
10-Year Average Return |
|---|---|---|---|
|
Waste Management |
3.7% |
61.5% |
7.8% |
|
McDonald's |
3% |
46.1% |
11.1% |
|
Fastenal |
1.7% |
44.1% |
12.5% |
|
UnitedHealth Group |
1.5% |
41% |
11.2% |
|
Range Resources |
0.4% |
37.3% |
29.7% |
|
Hudson City Bancorp |
5.1% |
36.6% |
19.1% |
|
Darden Restaurants |
3.1% |
34.1% |
15.2% |
Source: Yahoo! Finance and Capital IQ, a division of Standard and Poor's.
A couple of things stand out from this short list. First, although some of the stocks above have sizable current yields, none of them are incredibly high, compared to the 10%-plus yields you can find on many investments these days. Moreover, several come in with yields less than 2%, despite their fast growth rate. That suggests that even though they've enjoyed a long period of dividend success, they still have room to grow into the future.
The other noticeable attribute these stocks share is that they have all performed quite well, even though some have called the past 10 years the "lost decade" because of the overall stock market's flat performance. These stocks, however, have been anything but flat, and long-term investors have benefited from their solid payouts.
Protection from the storm
Of course, even these stocks weren't immune to hard times along the way. Most of them suffered declines during the bear market of 2008 and early 2009, as the financial system came to the brink of collapse. Even with their impressive gains over the past decade, several of them currently have their stock prices languishing well below their former highs. If you think that dividend stocks are a one-way ticket up for your portfolio without any bumps along the way, you're setting yourself up for a major disappointment.
Moreover, you can't count on the dividend growth list for the next 10 years coming from this list. Most of these stocks raised their dividends from a pittance back in 2000, and now that they've established themselves as consistent dividend payers, they're unlikely to sustain the break-neck pace of payout increases that they've seen in the past decade. That doesn't mean that they're bad investments, but again, if you're expecting to see those dividends keep rising at a 40% annual pace, reality is going to set in sooner than later.
Look for growth
The general point, though, holds true: Dividend growth can be even more attractive than a high current yield, especially if you have a long time horizon for your investing. So even though those high yields are the most obvious sign of a powerful dividend stock, looking beyond them to signs of future growth could pay even larger rewards.
Need more good ideas? Matt Koppenheffer has seven dividend stocks you can buy right now.
