(09/26/2011) When was the last time you seriously thought about the power of compounding? No, don’t stop reading and leave this article. I know you’ll find it interesting and
helpful if you follow it through to the end.
Seriously, compounded dividends provide a very powerful investment benefit. I’d like to compare the income of high quality, blue chip dividend stocks to that of intermediate-term bonds. Why? Because in almost a four decade career in investment management, I’ve never seen such a disparity of returns.
Let’s take a quick look at what I’m talking about. I promise this will be painless.
The current yield on a 5-year U.S. Treasury note is .84%. What will the rate be as it finishes its full term? Yup, you got it: .84%. Interest rates on Treasuries are fixed. That’s why we call bonds “fixed income.”
With stocks the income is anything but fixed. Dividend rates can rise, and they can fall. There are thousands of stocks trading in the U.S. but, as of the end of last year, only about 200 had increased their dividend rate for 10 consecutive years. That’s down 100 names from three years before.
Yet, there are a number of companies that have proven their ability to reward shareholders year in and year out with a growing income stream. I’d like to illustrate how important this can be to your investment return. The numbers in parentheses are consecutive years of dividend boosts.
| Price | Div. | Yld. | Gr. Rate | 5-yr. Div. | 5-yr. Yld. | |
| Abbott Laboratories (38) | 50.90 | 1.92 | 3.8% | 9% | 2.95 | 5.8% |
| Emerson Electric (54) | 42.84 | 1.38 | 3.2% | 6% | 1.85 | 4.3% |
| Pepsico (39) | 60.20 | 2.06 | 3.4% | 6% | 2.76 | 4.6% |
| Procter & Gamble (57) | 61.06 | 2.10 | 3.4% | 7% | 2.95 | 4.8% |
| Realty Income REIT (16) | 33.02 | 1.74 | 5.3% | 3% | 2.02 | 6.1% |
| Sysco (34) | 25.86 | 1.04 | 4.0% | 5% | 1.33 | 5.1% |
| 3M (52) | 73.82 | 2.20 | 3.0% | 12% | 3.88 | 5.3% |
| UGI (23) | 26.56 | 1.04 | 3.9% | 6% | 1.39 | 5.2% |
| Average (39) | 3.75% | 5.15% |
The eight companies listed above all represent different industries. On average, they’ve increased their dividends for 39 consecutive years. Pretty reliable, don’t you think? Their current payouts yield more than 3.7%, almost 4.5x that of the 5-year U.S. Treasury note, and much more than a similar length corporate or municipal note. These income winners are expected to ramp up their average dividend rate by 6.75% annually over the next 5 years, as forecast by Value Line. At end of that period, the mean yield should be 5.15%.
Here is your first quiz question: What will the 5-year Treasury note yield at the end of its term? You’re right: .84%. See how easy that was! So, what would you prefer to own over the next half-decade – a note that pays .84%, or a group of proven dividend payers that distribute 3.75% and should increase that rate to 5.15%?
Let’s not forget that stocks are more volatile than bonds and are, in fact, less safe. On the other hand, all of these 8 equities have an S&P Quality Ranking of A+, A, or A-. They have proven track records.
Now for our final quiz questions. What investment factor have we yet to mention? I hope you said “growth.” Will the bond grow in value over its 5-year tenure? No. What about stocks? We don’t know, but history indicates they might appreciate as much as their estimated earnings growth, which consensus estimates indicate is 9%. Even if they rise at just half that rate, some of us would be happy with the result.
Personally, I have never known a more attractive time to buy and hold great companies with rising dividends. I’m not predicting we’re at a bottom in the stock market or in these particular issues. I’m just saying that it’s hard to find investment selections with more attractive features.
If you would like to learn more about dividend stocks, contact us. And, if you think someone else might enjoy this analysis, please forward it to them and tell them we will gladly add them to our e-mail list.
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