Investments that pay dividends are attractive to people for a number of reasons. Passive income is usually a preferred item in the minds of most investors. Whether it is passive income you see or not, as an investor, you need to not let yourself get lost in looking for the company with the highest dividend yield.
It might seem counter-intuitive, but going for a high yielding company is not always the best play as an investment. I do not mean to make an argument here about how high yielding stocks are inherently riskier than X class of stock. My argument hinges on the fact that some companies have a historical track record of dividend growth, while others do not.
Dividend growth is extremely important to any investor that is drawn to a stock/fund because of its yield. This is especially true for long-term inventors. A track record of dividend growth can lead to very large regular distributions of passive income (dividend income).
For example, a company that you likely have a product of in your house is Pepsi (PEP). It’s an international company, has great brand recognition and makes drinks and snacks that are enjoyed by people of every walk of life.
From a quick glance at PEP’s historical performance you will see that they have a strong history of paying quarterly dividends. With a second look you’ll see that they also have been steadily increasing their quarterly payout amount for over 20 years.
For the sake of this example, let’s look at the last 5 years. In the last 5 years PEP’s dividend has grown annually by an average of 12.77%. If that trend continues, you’re effective yield based on your initial buy-in price is going to become very large. Think about this…If PEP’s dividend growth rate holds, a 3% dividend yield (around what PEP currently yields) will turn into a near 10% yield based off your initial purchase price in a matter of 10 years. This is what building wealth is all about.
If you plan to hold a stock for a number of years and a dividend payment is one factor that you’re being drawn toward, make sure to consider the historical growth shown in the stock’s dividend payment. Even a company that has a larger dividend yield may not be superior in the long-run to a company that has shown a commitment to growing its dividend distribution.
Disclosure: No Position
Most people, myself included, do tend to focus on the yield and really don’t even think about the growth rate of the dividend. This is a great reminder and wonderful suggestion.
In all honesty, I wish someone had brought this fact to my attention years ago. When I started to do some analysis on my own I started to think about the implications. It’s one of those items that I think most investors are aware of, but they do not really give it much weight.
[...] The Market Capitalist presented Dividends – Focus on the growth rate, not the yield [...]
[...] The Market Capitalist presented Dividends – Focus on the growth rate, not the yield [...]
There are three basic categories of stock investors. The first is the Capital Growth investor. He is looking to purchase a stock at a given price and sell it for more than he paid for it. The second is the dividend investor. He is looking for dividend paying stocks and he buys them for yield. Then there is the dividend growth investor. He buys dividend paying stocks that have demonstrated that they will consistently pay a dividend, that they consistently raise that dividend, and that they have a sustainable dividend. This investor is concerned about “YIELD ON COST.” I know that the KO shares I purchased for 61 yield a little more than 3%. In 10 years, with the increase in dividends, my KO purchase will yield 12% on my cost. In 10 years, a person buying KO may see a 3% yield on his new investment. The reason is that yield and price march together. Check it out at Seeking Alpha.
Thanks for pointing this out … it certainly makes a different in your final return as you pointed out.
[...] The Market Capitalist presented Dividends – Focus on the growth rate, not the yield [...]
[...] The Market Capitalist presented Dividends – Focus on the growth rate, not the yield [...]
[...] History of Rising Dividends Is Indicative of Company Success A couple weeks ago I wrote about the significance of the dividend growth rate for long-term investor…. Since that time I’ve given more thought to the subject. It should not be forgotten that [...]