Image: American Tower
By Brian Nelson, CFA
Over the past decade, I have grown to appreciate the compounding dynamics of reinvested dividends on appreciating stocks even more than some of the most widely distributed historical studies have revealed. The strategy of dividend growth investing not only benefits from the reinvestment of dividends into the purchase of new stock, but it also benefits from the higher dividend payments on an ever-increasing number of shares owned by the investor. This means that dividend growth investing results in a compounding dynamic that is even better than that of compound interest, which is calculated on the fixed starting principal and the accumulated interest from prior periods like that on a bond, for example.
This dynamic is worth emphasizing. Let’s assume we have two securities. We have a bond that pays an annual interest rate of 3%, and it experiences compound interest over a period of 35 years. We also have a stock that pays a starting dividend yield of 3% and increases its dividend payment 3% per annum over the next 35 years. All proceeds from the dividends are reinvested to purchase new shares, and the stock’s price advances at a modest 3% annual rate over this time period. Did you know that after 35 years, the total value of the shares due in part to dividend growth compounding was nearly 3 times greater than the bond generating compound interest and nearly 8 times greater than their starting value.
There’s more to the dividend growth strategy than just the compounding dynamics of reinvested dividends, too. Investors can achieve a very attractive income yield on cost for retirement. The income yield on cost is generally calculated as the current annual dividend rate of the stock divided by the original cost basis of the stock. For example, for the same hypothetical company in the example above–the one that started paying a dividend yield of 3% and that increased it 3% each year for 35 years–the yield on cost for the investor would have grown to over 8%! That’s significantly higher than the starting 3% yield, and it may be high enough to fund a very nice retirement, especially in a world where CDs and bond yields are so paltry. What’s more, the company only increased its dividend 3% per year to achieve that nice yield on cost, and there are many stocks on the market today that are poised to increase their payouts at a much faster pace in the coming decades, in our view.
In general, companies that pay dividends and seek to grow them over time are often ones that are moaty (competitively advantaged) and generate strong and growing free cash flows. This is where we think we add tremendous amounts of value in the process. The Dividend Cushion ratio, which is available in our screeners and in the dividend reports, considers both our forecasts of a company’s future expected free cash flows and the health of its balance sheet to assess whether a company has the capacity to keep paying a growing dividend long into the future. We love stocks that have huge net cash positions and strong future free cash flow growth potential, as we think these are the ones that will be the best dividend growers in the years ahead.
For example, since Valuentum’s inception, we’ve used Microsoft (MSFT) as the quintessential example of the type of long-term dividend growth stocks we like. In our inaugural Dividend Growth Newsletter, released January 2012 (more than 10 years ago now!), we assigned Microsoft a portfolio weighting of 8%, the highest among constituents at the time. Back in January 2012 when the newsletter was published, Microsoft’s share price was $25.96 while it paid an annualized dividend of $0.80 per share. The software giant’s shares are now trading for $310+ each (up 12-fold since then), and its annual dividend rate is now $2.48 (more than tripling), reflecting a yield on cost of ~9.6% (the current dividend payout per share divided by the cost basis, or $2.48/$25.96). By any measure, this long-term dividend growth idea has been a home run!
Let’s cover three dividend growth ideas that just raised their payouts.
American Tower Corporation
On March 11, American Tower (AMT) declared a $1.40 per share quarterly dividend ($5.60 per share annualized), a 0.7% increase from its prior payout. We’re huge fans of the tower stocks due in part to their moaty business models and strong free cash flow generation. Though American Tower has a huge net debt position, we like the scale and EBITDA leverage behind its business model; its net-debt-to-annualized-free-cash-flow ratio isn’t as high as some of its other REIT peers either. We include AMT as an idea in the High Yield Dividend Newsletter portfolio and expect more dividend increases from the tower giant to come. Shares yield ~2.2% at the time of this writing.
Read more: High Yielding American Tower Is a Free Cash Flow Cow (Feb 23, 2022) >>
Qualcomm Incorporated
On March 9, Qualcomm (QCOM) declared a $0.75 per share quarterly dividend $3.00 per share annualized), which reflected a jump of more than 10% from the prior dividend. Powerful secular tailwinds support Qualcomm’s longer term growth outlook in the realm of 5G, AI, autonomous and semi-autonomous driving activities, the Internet of Things (‘IoT’) trend, and more. Qualcomm views its addressable market opportunity growing by $100 billion by 2030 to hit $700 billion. With a dividend yield of ~2% at the time of this writing, the company’s equity is hard to pass up. It’s included in the Dividend Growth Newsletter portfolio.
Read more: Dividend Growth Idea Qualcomm Growing Robustly (February 2, 2022) >>
Dick’s Sporting Goods
On March 7, Dick’s Sporting Goods (DKS) declared a quarterly payout in the amount of $0.4875 per share, representing an 11% increase and one that is equivalent to an annualized dividend of $1.95 per share. The company has a habit of increasing its payout at a lofty rate and even paying special dividends, which we like. Stellar free cash flow generating abilities and a pristine balance sheet are immense sources of strength for the sporting goods retailer. Shares yield ~1.9% at the time of this writing and are also a part of the Dividend Growth Newsletter portfolio.
Concluding Thoughts
We hope you enjoyed these three dividend growth ideas that just raised their payouts.
Our team combines our extensive knowledge of enterprise valuation (i.e. the discounted cash flow process), its cash-based intrinsic value components, competitive advantages, long-term secular growth trends, technical/momentum indicators and yield/income considerations to highlight what we think will be some of the strongest dividend growth companies and most resilient business models in the years to come. We calculate forward-looking Dividend Cushion ratios for key companies in our coverage and provide a simulated newsletter portfolio in each edition of the Dividend Growth Newsletter.
The Dividend Growth Newsletter portfolio >>
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Disclosure: Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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