Dividend enthusiasts understand the value of receiving those quarterly payments, which really add up over time. For investors who’d rather not have to keep their eyes glued to every market headline, pinning their retirement hopes and dreams on the daily prices of their stocks, dividends are a reliable source of returns. Dividends allow you to sleep well at night, knowing that those checks will arrive, regardless of the prevailing economic climate.
Few metrics have the ability to convey the true power of dividend growth as much as the concept of ‘yield on cost,’ which measures the percentage of an investor’s initial investment that they currently receive as dividend income. For example, while the market’s most well-known dividend-paying stocks will pay between 3% and 4% for new investors, regular dividend increases mean that over time an investor will receive much bigger payouts when compared to their original investment.
The most powerful force in the universe
It’s rumored that Albert Einstein once stated that compounding interest was the most powerful force in the universe. Whether or not he actually said the words is less important than the value of the message. Those who understand the wonders of dividend growth will likely see the truth in such a statement.
Consider the fact that if you had a $100,000 portfolio and 15 years until retirement, you could build a yield on cost of 10%, provided that you picked stocks with dividend yields of at least 3% and raised their dividends by 9% compounded annually.
While a 10% yield on cost might not sound like much, it means that same $100,000 portfolio would generate $10,000 in yearly dividend income after those 15 years, which can help pay for a lot of life’s inevitable expenses.
A basket of stocks to get you started
Picking stocks with 3% yields and 10% dividend growth might seem like a daunting task, but really, it simply involves focusing on the best dividend stocks the market has to offer. While these figures are ambitious goals, it’s absolutely possible to craft a portfolio with stocks that hit the target.
Even better, you don’t have to scour the Earth for obscure stocks you’ve never heard of. Plenty of America’s biggest companies have dividend track records that meet, and in some cases exceed, 10% annualized growth. And, even though the markets continue to breach new highs, it’s still entirely reasonable to secure 3% yields.
For example, Dow Jones Industrial Average components Intel Corporation (NASDAQ:INTC), McDonald’s Corporation (NYSE:MCD), and Chevron Corporation (NYSE:CVX) each pay dividends in excess of 3% annually. In fact, Intel Corporation (NASDAQ:INTC)’s yield is actually more than 4%, meaning your yield on cost will be even greater over time.
Speaking of Intel Corporation (NASDAQ:INTC), even though the stock has yielded nearly 4.2% recently, the company’s dividend growth is more indicative of a low-yielding, high-growth stock. Intel Corporation (NASDAQ:INTC) has raised its dividend by 12% compounded annually over the past five years. The only reason a stock with this kind of dividend growth profile yields so much is that Intel Corporation (NASDAQ:INTC) shares have been punished severely over the past year, and now trade for a measly price-to-earnings ratio of just 10 times.
McDonald’s and Chevron have business models with nothing in common, yet the stocks share similar dividend profiles. Each stock pays slightly more than 3% and have raised their dividends every year for many years. McDonald’s and Chevron have increased their shareholder payouts by 15% and 9%, respectively, over the past five years.
One stock that gives investors the best of both worlds, namely high dividend growth in addition to a high yield far above 3%, is Altria Group Inc (NYSE:MO). The tobacco giant has a five-year compound annual dividend growth rate of 9%, and a huge current dividend yield in excess of 5%. This unbeatable combination is what made Altria the best-performing stock from 1925 to 2003, according to noted Wharton economist Jeremy Siegel.
It sure adds up
Plainly stated, the concept of yield on cost provides clarity into the true value of dividend growth over time. Investors may grasp the notion of the benefits of owning stocks that raise their dividends regularly, but showing it as a percentage really brings home the point. With time and patience, an investor can derive huge income from their stocks. Keep in mind that if you’re willing to reinvest those quarterly dividends into more shares of these stocks, your yield on cost will rise even faster, and you’ll meet the target even quicker.
Investors who benefit the most from this concept are those with longer time horizons, who have more time to let their dividends compound. These stocks have demonstrated clear intentions of rewarding shareholders with rising dividends, proven by their extremely long track records of doing just that. If you’re an individual who still has a ways to go before retirement, these stocks can do wonders to secure your financial future.
The article The Beauty of Dividend Growth, And 4 Stocks to Prove it originally appeared on Fool.com and is written by Robert Ciura.
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