Compound interest is the greatest wealth-building tool in any investor's toolbox. Time plus interest equals big money.
The same super-simple calculation is also the key to successful dividend investing. Great dividend-paying stocks keep their payouts steady for decades at a time, tapping right into the magic of compound interest.
But the best dividend stocks deliver a double dose of compound returns, because they don't just make rock-steady payments every year. They grow their payouts like a Swiss-made clockwork, so the effective interest rate keeps increasing as well.
Compound returns on top of compound returns -- now that's a cash machine if I ever saw one!
Let's take a look at three classic dividend growers: Procter & Gamble (NYSE:PG), Altria Group (NYSE:MO), and McDonald's (NYSE:MCD). These classic cash machines have increased their payouts without fail for at least 37 consecutive years, creating heaps of investor wealth in the process.
First, there's something to be said about a solid core business. All three of these companies have delivered exactly what consumers wanted, needed, or were addicted to for decades on end. So before even looking at the wealth-boosting effects of rising dividend payments, the stocks have absolutely crushed the S&P 500 (SNPINDEX: ^GSPC) market index in the long run:
In an effort to compare similar fruits, this chart goes back to 1977 which is where McDonald's started its uninterrupted dividend-boosting run. Altria got started in 1970, while Procter & Gamble's perfect history of dividend increases stretches back to 1957.
On a split-adjusted basis, fast-food veteran McDonald's paid out $0.002 per share in 1976. Today, the annualized dividend stands at $3.40 per share. In other words, McDonald's has multiplied its dividend payouts by 1,370 in 37 years. On average, that's an annual increase of 21.6%.
Have these dividend payouts made a difference to McDonald's investors? You bet. Reinvesting dividends along the way would have increased your already fantastic return on an early McDonald's investment by another 60%:
The dividend difference grows even larger when we turn to all-around consumer goods giant Procter & Gamble. At the start of our McDonald's-matching chart, P&G's split-adjusted annual payout stood at $0.07 per share. Today, the payouts have multiplied to $2.58 per share, per year. And these rising payouts would have doubled your returns since 1977:
But the real dividend king here is tobacco wrangler Altria. Across the 37-year span we're looking at today, Altria's annual dividends per share have grown from $0.02 to $2.08, with spectacular results for patient dividend investors:
These three stocks offer respectable dividend yields on new investments, too. From P&G's 3.1% yield to Altria's 4.6%, these stocks will beat any savings account in terms of short-term returns on your invested dollar.
But as the charts and figures above demonstrated, the real magic of dividend investing comes from letting the payouts ride over the long haul. Compound interest is a powerful thing, especially when you layer growth on top of more growth.