With interest rates and bond yields at extremely low levels, many investors are chasing the high yields offered by a number of risky dividend-paying stocks. But buying companies simply because of the size of the dividend isn't something more conservative investors should be doing. If a 10% to 15% yield is what you are looking for, you may not have to search as far as you think.
What's your real yield?
When you look at the performance of your portfolio, the return on investment is based off the price you paid for different stocks. So why don't we follow the same logic when looking at dividend yields of stocks? I'd say that when you own a stock and it pays a dividend, you shouldn't care about its current yield; instead, you should focus on the current dividend compared to the price you paid for the stock.
For example, say you had bought the following four companies 10 years ago for your portfolio:
Recent Share Price
Current Annual Dividend per Share
Yield Based on 2002 Price
Source: Yahoo Finance; author's calculations. 2002 prices adjusted for splits.
Over the years, rising dividends have increased the stocks' dividend yields when you compare them to their original share prices. Now, McDonald's pays 10% of your purchase price annually in dividends, and the others are getting close to double-digit percentage payouts.
Sometimes this works even better with growth companies that don't even pay dividends at the time you buy them. For instance, if you had bought Apple 10 years ago, you would have paid less than $13 per split-adjusted share. With Apple's new dividend of $2.65 per quarter, you'll have your entire initial investment paid back to you in the first five quarters.
Still worth buying?
As you can see, these five companies would all have made wonderful buys 10 years ago, but the real question is, "Are they still worth buying today?" I believe they are. Other than Apple, these companies have all boosted their annual dividend payouts every year for 25 years or more. But more importantly, each of these companies has specifics that make it worth buying.
McDonald's is the clear-cut leader in the fast-food business, with No. 1 market share in nearly all of the countries in which it does business. The Golden Arches saw same-store sales increase 7.3% in the most recent quarter. Its growth continues to impress.
Chevron may be in second place behind Exxon in terms of market cap among U.S. oil companies, but Chevron's dividend yield is significantly higher than Exxon's, even after both of them raised their payouts recently. Chevron also has a cheaper valuation than Exxon based on earnings.
Nucor bears the title of North America's largest recycler, with steel production and scrap-metals brokerage among its businesses. The company's modern and efficient "mini-mills" format helps save the company on costs, helping it stand out from many of its peers.
HCP currently boasts a portfolio of over 1,000 health-care facilities, and with an aging U.S. population, future revenue should remain fairly consistent. The company gets the majority of its revenue from senior housing and skilled-nursing properties, and a big portion of its sales comes from private-pay patients, rather than government reimbursements, helping shelter it from health care reform effects.
Last but not least, while most investors talk about Apple's future growth prospects, I believe you should buy it for the dividend. Based on first-quarter earnings per share, Apple's dividend payout ratio will be around 21%. If Apple continues to grow rapidly, and management wants to keep the payout ratio around 20% to 25%, the dividend will also continue to rapidly increase. If growth slows down to a normal pace, the board still has plenty of room to increase the dividend, as the payout ratio is low (not to mention Apple's $110 billion in cash sitting in the bank.)
Regardless of a company's dividend yield today, long-term buy-and-hold investing in financially solid companies can turn modest payouts into cash cows over time. Start building a portfolio today that will be producing yields of 10% or more in the future by getting this Motley Fool special report on safe, dividend-paying companies. Just click here.
Fool contributor Matt Thalman owns shares of Apple. The Motley Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Chevron, Nucor, McDonald's, and Apple, as well as creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.