- It is the combination of dividend yield and dividend growth which creates the magic of dividend investing.
- Combining high yield and high growth can have dramatic impacts on your income.
- I highlight 7 high quality picks with both high yields and high dividend growth.
Written by Sam Kovacs
About a month ago, I published a list of 5 high dividend growth stocks which dividend investors should consider.
I made the case that dividend yield and dividend growth shouldn’t be considered in isolation, but only relative to one another.
After all, while a 4% yield is good, is it really great if there is no dividend growth?
In a similar way, is dividend growth of 15% worth getting excited if the stock yields less than 1%?
The answer to both those questions is no.
Dividend yield matters. It is the base income which you’ll see grow in upcoming years.
Dividend growth matters. It is the magic which makes dividend investing so attractive.
A low yield high growth example
Consider the following.
If we take a low yielding, high dividend growth stock, like Home Depot (HD).
The stock yields 2.1%. Last year, the company grew the dividend by 10%, although the company averaged 20% growth for the past 5 years.
Let’s assume HD grows the dividend at 12% per annum for the next 10 years. You invest $10K in HD, and reinvest the dividends once a year, at the same yield.
In 10 years, you could expect to receive $787 in dividends, of which $135 will come from having reinvested dividends.
A high yield low growth example
Now let’s consider a stock with a high yield but low dividend growth prospects: IBM (IBM).
The stock yields 5.6%, but has only increased the dividend by 0.6% this year.
Let’s assume you once again invest $10K, and reinvest the dividends once a year.
This time, in 10 years, you could expect $1,059 in dividends, of which $409 would come from having reinvested dividends.
This is better for income, but don’t forget that the capital appreciation of such a position will likely be a lot less than for a stock growing its dividend at 12% per annum.
A high yield high growth example: Abbvie
Now let’s look at Abbvie (ABBV).
Abbvie yields 5.6%. The dividend grew 10% last year, but it has averaged 18% over the pas 5 years.
Let’s say it can continue growing the dividend at 10% per annum. A $10K investment with annual dividend reinvestment would yield an eye watering $2,339 in a decade.
$895 would come from having reinvested dividends. But even if you factor out dividend reinvestment, it is clear to see how the combination of dividend yield and dividend growth is attractive.
ABBV is just the first of 7 such stocks which I suggest investors buy.
A quick look at the MAD Chart shows ABBV’s yield is nonsensical relative to the rates dividend investors could expect during the past decade. A fair range (shown by the pink and light blue areas on the chart) implies a dividend yield of 3.18% to 4.42%. Anything above 4.42% is historically cheap. ABBV yields 5.6%.
What’s more, the dividend is very well covered.
Operating cashflow payout ratios have been stable between 41% and 55% for the past 5 years despite the dividend doubling in that time frame.
Brad Thomas makes a compelling case of why to purchase Abbvie in his recent article.
Abbvie is 1. A high quality company, 2. Committed to rapidly growing the dividend. 3. Way undervalued on any reasonable metric.
Buying at these prices should generate positive long term results.
The list of 7 stocks.
Here is the full list of stocks that will be covered in this article.
Before we look at them, it is important to understand how the list was constructed.
I first looked for stocks which yielded at least 3.4%, or twice the S&P 500’s (SPY) yield. I then looked for stocks which had grown the dividends at least at a 10% CAGR over the past 5 years, favoring those which grew income at least 10% in every single year.
I then weeded out all the stocks which didn’t match my quality requirements. This leaves us with a small list of very high quality names which can form a strong base to a dividend portfolio in these uncertain times.
AVGO is a crowd favorite among dividend investors, and for good reason. Last year the dividend grew 20% while it grew at 50% per annum during the past 5 years. It is hard to project the rate of growth over the next 10 years, but when we consider that the dividend is still a very reasonable 60% of free cash flow, it is hard to see the dividend growing at a rate any lower than 10% per annum over the period.
This is very attractive in light of the company’s 3.5% yield.
Just consider the $10,000 investment we mentioned earlier, assuming 10% growth (which is on the low end of what I expect for AVGO), and annual dividend reinvestment.
You could expect income of $1,190 10 years from now.
If AVGO can pull of 12% CAGR, which is much more likely, that number would jump to $1,460.
We estimate that a stellar investment is one which, in a decade, can produce 10% on the original investment including reinvestments.
It is no news that I like semiconductor stocks. I have always been a big fan of Texas instruments (TXN). I own both stocks, but TXN is no longer in my buy zone (TXN is great above a 2.5% yield), whereas AVGO has historically been a great buy when it has yielded above 2.9%.
Cogent Communications (NASDAQ:CCOI)
Cogent Communications is a fiber infrastructure stock, which is in a high growth market and growing the dividend aggressively.
Since 2016, the dividend has been growing at $0.02 per quarter, which has resulted in 15.6% CAGR during the past 5 years, or 13.3% over the past year.
In the meantime the stock yields 4.72%, well above its fair range of 3.22% to 4.19%.
Even if the company can keep up the $0.02 per quarter increase, a decade from now, the dividend will have grown at an 8% CAGR.
A $10,000 investment in CCOI with annual dividend reinvestments would yield $1,527 in a decade.
This number is once again way beyond our 10% in a decade threshold. Cogent is not popular right now, but for no good reason. It is a well run company, in a high growth industry. In fact, management expects top line to grow at a double digit rate for the next 5 years, enabling the company to keep aggressively growing its dividend.
Anything oil related is so unpopular, it is beyond reason. Some of the highest quality assets out there are trading at crazy prices.
Consider Enbridge. While revenues were down 41% YoY in Q2, cost of revenue declined by 60%. This resulted in only an 8% reduction in operating income, or a 4.7% reduction in net income. Operating cashflow remained flat.
Yet the stock is down 21% in the past 12 months, and still down 30% from pre pandemic levels.
This has given ENB a massive 8.4% yield, which the company can afford.
At the current rate of $2.35 per annum, the dividend consumes about 60% of operating cashflow, or about half of the company’s so called “distributable cash flow”.
Enbridge isn’t your average shaky oil stock. Its operations have been resilient through all market cycles, thanks to high quality clients, a superior network, good management. This has allowed the company to maintain its investment grade rating and grow the dividend at 14% per annum since 2008.
Let’s turn to our MAD Chart. During the past 10 years, ENB has gone from being a low yielding stock to an ultra high yielding stock.
The fair range of yields (shown by the pink and light blue areas) spans from 2.85% to 5.65%. All this really tells us, is the market has increasingly viewed ENB as a risk asset (although its not). The company’s dividend has rarely been taken into account in keeping the stock’s value in check. If we change the fair range of yields into a fair range of prices, what we can tell is that ENB is worth between $40 and $80.
That doesn’t tell us much, except that at $29, it is significantly undervalued.
Let’s play a game. This game is called Enbridge’s dividend growth is going to be only 1/3rd of what it has been the past decade, or about 5%. This is reasonable, given management’s expectations for distributable cashflow to grow at about 5-7% per annum.
If you invested $10,000 in ENB at 8.4%, that the dividend grew at 5% per annum and you reinvested the dividend every year at that same yield, in 10 years you could expect mind blowing income of $2,810 per year, of which $1,439 would come from having reinvested dividends.
Now the big question here, is whether the market will always value ENB as an 8.4% yielding stock. What happens if you invest at 8.4% now, but that the market wakes up, revalues ENB and you can “only” reinvest the dividends at a 5% yield (within the fair range)?
Then you’d still receive $2,117 in dividends per year a decade from now, without mentioning that at a 5% yield, your position would be worth over $40K a decade from now, or a total return of about 14%.
Anyway you look at it Enbridge is a bargain. I see no way of an investment at these prices going wrong. It is a surprise that I haven’t looked at it closely earlier this year, but it is just too good to pass up. I’m initiating a position now.
JP Morgan Chase (NYSE:JPM)
A couple of weeks ago, I mentioned how much I liked JPM in an article on the 10 most popular stocks on Seeking Alpha.
The company is one of the best banks around, yet offered a strong 3.5% yield, well above the company’s historical fair range of 2.33% to 2.92%. In my opinion this is mostly because the fed has put pause on dividend increases from banks. As soon as they lift this freeze, I expect banks like JPM and Bank of America (BAC), to increase their dividends generously to show their confidence in their balance sheets.
The big bulge bracket banks are not the same companies they were over a decade ago. They have fortress balance sheets, thanks to stringent capital requirements passed following the GFC.
The dividend has been growing at 15% per annum. Even if that decreased to 8% per annum over the next 10 years, a $10,000 investment in JPM would still yield over $1,000 in dividends, assuming dividend reinvestment, just passing the bar for a “stellar” opportunity.
JPM is one of the best of its class, and it offers a great yield.
Sometimes, successful investing in dividend stocks comes from buying high quality names when they are out of favor.
Of course, this relies on the fact that they are indeed high quality names. Otherwise, it would be near impossible to obtain stocks which have both high yields and high dividend growth rates.
With the exception of AVGO, all stocks in this list are hated on, for one reason or another. Enbridge is oil, so it’s hated no questions asked. JPM is a bank, and financials are hated. Abbvie is out of favor.
This is also certainly the case for Prudential Financial, a stock which went from yielding 2.4% 3 years ago to 6.4% today. Well above the fair range of 2.4% to 3.71%.
All this while the dividend continued to grow at a 13.7% annual rate between 2015 and 2020. The company has the liquidity to pay the dividend, and is extremely committed to it.
In a recent presentation management could be quoted saying:
“Dividends are the most important thing – we’ve said that. We will continue to prioritize dividends and seek to maintain them through the cycles, and then stock buybacks, when we feel we can start the program again, we will. “
Just like with Enbridge, it will be hard to go wrong with PRU. If the dividend were to only increase at a 5% CAGR over the next decade, a $10,000 investment with annual dividend reinvestments would yield as much as $1,811 in 10 years.
Even if all the dividend reinvestments happened at a much lower rate of 4%, you’d still expect $1,400 in dividends a decade from now.
Since a stellar investment is one that can produce 10% a year in 10 years, one that can produce 14% and 18% is a no brainer.
Trinity Industries (NYSE:TRN)
We get to the final stock on this list, another which investors might not have considered.
Trinity Industries manages a portfolio of railcars which it sells and leases throughout the US.
The following slide from its Q2 investor presentation provides a good overview of the company.
To those of you who are unfamiliar with the company, I strongly suggest you read through the presentation. It makes a solid case for railcars as an asset class:
- They produce stable and predictable cashflows.
- They are long lived assets with useful lives up to 50 years.
- They provide an interest rate hedge as leases go up with interest rates.
- Rail is an essential part of American infrastructure.
It is no doubt then, that management has managed to pay a dividend for the past 225 quarters, although the dividend was cut once in 2002, and took 10 years to get back to its prior level.
Nonetheless, the dividend has grown at a 20% CAGR over the past 10 years, a 19% CAGR over the past 5 years, and 11% last year, even though growth has been choppy, and not as consistent as I would have liked.
The stock yields 3.6%, well above its historical fair range of 1.16% to 1.91%.
If the dividend were to increase at 8% per annum for the next decade, a $10,000 investment would produce $1,061 in income a decade from now, assuming dividend reinvestments.
Last month I suggested buying Greenbrier (GBX), TRN’s main competitor. GBX has increased 10% since, and now yields the same as TRN. At current levels I think buying both is sensible, and I will be initiating a position in TRN.
Just take a moment to reflect on the power of combining yield and growth. We saw that while yield or growth alone can do a lot of heavy lifting, when you identify opportunities to get both, you can lock in a fantastic price which will supercharge your income in years to come.
Compounding a high yielder with high dividend growth makes dividend investing seem unfair.
To finish this article, I want to contrast with a stock which has neither a strong yield, nor strong dividend growth.
Let me bring your attention to the York Water Company (YORW). A fine company on all accounts, in an evergreen business.
Yet it yields a paltry 1.56%. Well below its fair range of 1.96% to 2.9%. But even within that fair range, the price just wouldn’t be that attractive.
The dividend has been growing between 3% and 4% per annum for the past decade.
If you were to invest $10,000 in YORW and reinvest the dividends yearly, in 10 years you could expect an impressive $264.
It will come as no surprise that YORW will be suitable as an investment only in the following scenario:
- You have enough money invested that a 1.5% yield can cover your expenses.
- You are so risk averse that you only consider investing in the safest of safest assets, regardless of the impact on your performance.
Otherwise, you want to focus on investing in high quality names, and once you’ve identified safe dividends, focus on maximizing your combination of yield and growth.
Author: Robert & Sam Kovacs
Source: Seeking Alpha: 7 High-Yield And High-Growth Undervalued Dividend Stocks To Buy Now