For most investors, dividend investing is considered a boring alternative to pure growth investing. However, this in no way means it is not a successful practice. In fact, when combined with growth investing, a simple dividend can become an incredibly powerful weapon.
The dividend difference
Successful dividend investing does not just mean finding a company that pays a high yield--it also means finding a company that steadily raises its dividend at a substantial rate. When dividends are reinvested, the compounding effects can greatly enhance returns over time.
Let's look at a few examples of dividend reinvestment in companies that have proven to be extremely strong dividend achievers over the years: W.W. Grainger (GWW +0.30%), Nike (NKE 0.79%) and VF Corporation (VFC 0.32%):
|
Company |
Grainger |
Nike |
VF Corp |
|---|---|---|---|
|
5-Year Return |
281.3% |
223% |
383% |
|
Total 5-Year Return |
315.5% |
249.5% |
455.8% |
|
% Difference |
34.2% |
26.5% |
72.8% |
Numbers courtesy of YCharts.com
In the table above, the "5-Year Return" is simply share appreciation while the "Total 5-Year Return" is share appreciation plus dividends reinvested. Notice the greater investor return when all dividends are reinvested.
In the case of Grainger, an investor netted an extra 34.2% over the course of five years simply by reinvesting all dividends paid by the company. In the second example, an investor gained an extra 26.5% by reinvesting all dividends paid by Nike. Finally, just by reinvesting all dividends paid by VF Corp over the last five years, investors gained an additional 72.8%.
VF Corp has traditionally had the highest dividend yield over the last five years, which accounts for the company's drastic outperformance in total returns. However, the results are certainly impressive for all three companies.
How it works
Although the difference in investor returns is substantial, dividend reinvesting is very easy to understand. The company pays dividends that are then reinvested for free by most brokers. All shares purchased via dividend then begin to earn their own dividends and the process simply continues in this way.
Also, with specific regard to companies that grow dividends consistently, the dividend growth rate also has a compounding effect on total return as it continues to build off of growth in all prior years.
The benefits
Aside from the most obvious benefit of greatly enhancing shareholder return, there are several other positives to dividend growth investing. The first is that it is a relatively easy thing to get started and requires little to no extra work thereafter.
When I first realized the advantages of reinvesting dividends, I simply called my broker up and told a representative that I wanted all payable dividends in each of my accounts to be reinvested. This was over five years ago and the process occurs in my account every quarter without me even realizing it.
The second benefit is that the method offers investors protection from some of the general market's volatility. This is especially valuable when dealing with rapidly growing stocks that pay dividends, as the often-volatile nature of these types of equities can be taken advantage of through the systematic purchases of shares via dividend reinvestment.
The rare combination
As wonderful as the benefits of dividend growth investing are, their impact can be drastically enhanced when combined with rapidly growing companies.
Grainger, Nike and VF Corp are prime examples because in addition to offering solid yields and increasing dividends, the companies are all growing revenue and earnings per share well. This subsequently enhances share appreciation and makes each dividend reinvestment more valuable.
Since companies that can excel on multiple fronts like these are exceedingly rare, they deserve special consideration from all long-term growth investors.
