Lessons in Dividend Stock Investment that Could Prove Profitable in 2025
The year's end serves as an ideal time for appraisal of your investment trajectory. Part of this assessment involves recognizing and avoiding blunders or executing portfolio adjustments before the year concludes. Additionally, you could delve deeper into a particular segment or stock category, such as growth stocks versus value or dividend stocks.
Here are three lessons that can assist in selecting successful dividend stocks for purchase and retention in the upcoming year.
1. The significance of income growth
Investors are frequently drawn to companies with a history of regular dividend hikes. However, this can be economically detrimental if the company isn't experiencing earnings growth. For instance, if a company is allocating all its profits to shareholders in the form of dividends, yet continues to accrue debt, it could negatively impact the company's health and, ultimately, make it an unworthy investment.
The most prosperous dividend-paying companies should at least match their earnings growth rate with their dividend increase. An exemplary case is Procter & Gamble (PG -0.51%), a Dividend King with 68 consecutive years of dividend increases -- an unimpeachable track record. Over the past decade, P&G has expanded its diluted earnings per share at a slightly higher rate than its dividend. It has also managed to acquire significant amounts of stock to decrease its share count by 12.8%.
Earnings and dividend growth have bolstered P&G's value. Shareholders who have held P&G stock for the past decade have benefited from a 92.3% increase in stock price. However, the total return (accounting for dividends) is substantially higher at 155%. P&G demonstrates how a company with mediocre earnings and dividend growth can be an exceptional investment due to consistency.
Consistency is a crucial attribute to consider when dealing with dividend stocks. Investment is fundamentally about trade-offs. Growth stocks offer better potential for substantial gains, but can be volatile and inconsistent. Conversely, investors frequently opt for dividend stocks in search of something more predictable, which aligns with their financial objectives or risk tolerance, or to supplement income in retirement. Often, the best dividend stocks are also the most consistent.
Sherwin-Williams
2. The fallacy of yield
$192.85
Dividend yield is a company's annual dividend payment divided by its market capitalization (or, more simply, the dividend per share divided by the stock's price per share). If dividend increases outpace the stock price, the yield will rise. Conversely, if the stock price outpaces dividend growth, the yield will decrease. The optimal combination is a company that consistently raises its dividend by a significant amount while also growing in value, resulting in a greater shareholder return driven by capital gains and dividends instead of merely dividend income.
$384.96
There are numerous high-quality dividend stocks with low yields due to substantial stock price growth. An unexpected recent example is Walmart (WMT 0.87%). Walmart is a stable, leading industry company, also categorized as a Dividend King. However, the stock has witnessed an outstanding 88.3% increase in the last year. Walmart's long-term investments are paying off, and it is taking market share during a period when many of its rivals are struggling. The significant increase in Walmart stock has reduced its yield to below 1%, rendering it an inefficient source of substantial passive income. But, Walmart's commitment to growing its dividend remains strong.
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Costco Wholesale (COST 0.74%) is another retailer that has outperformed the market on numerous occasions. Costco is a distinctive case because it has a modest regular dividend but occasionally pays substantial one-time special dividends when its cash balance reaches an optimum level. Costco utilizes dividends to directly return capital to shareholders. Once again, Costco is not suitable for investors seeking consistent and regular quarterly dividend payments, but its dedication to using dividends to return capital is evident.
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Another company, Sherwin-Williams (SHW 1.01%), is primarily known for its paint business. It's also an exceptional dividend stock that has consistently surpassed the broader market. Sherwin-Williams had an exceptional year. In February, it boosted its dividend by 18.2%, marking the 45th consecutive annual increase. In November, it joined Nvidia as the most recent additions to the Dow Jones Industrial Average.
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Over the past decade, Sherwin-Williams has more than tripled its dividend, but the stock price has quadrupled. Despite a yield of just 0.7%, its shareholders remain indifferent due to the remarkable gains.
Microsoft (MSFT 1.14%) spends more on dividends than any other U.S.-based company. Over the past decade, Microsoft has hiked its dividend by around 8% to 11% annually, while also repurchasing enough stock to more than compensate for its equity compensation expense. However, due to the company's enormous value and faster stock price growth than its dividend hikes, the yield is only 0.8%.
Microsoft
Walmart, Costco, Sherwin-Williams, and Microsoft might not offer a substantial return if you buy their stocks today, so it's wise to view them as growth stocks rather than value or income stocks. However, they provide substantial returns for long-term investors when considering the cost of investments.
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In my viewpoint, yield on cost is frequently overlooked when discussing dividend stocks. Yield on cost is the most straightforward method to prevent penalizing a company due to its strong performance. Instead of dividing the dividend per share by the current share price, you should divide the dividend per share by the purchase price of the stock.
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To illustrate, let's suppose you bought Sherwin-Williams five years ago at $192.85 per share, when the stock offered a quarterly dividend of $0.377 per share. Similarly, you purchased Microsoft for $151.75 per share with a quarterly dividend of $0.51 per share. At the time of writing, Sherwin-Williams has a share price of $384.96 and a quarterly dividend of $0.715, while Microsoft has a share price of $443.57 and a quarterly dividend of $0.83 per share.
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| Company | Hypothetical Cost Basins | Current Share Price | Current Annualized Dividend | Current Yield | Hypothetical Yield on Cost || --- | --- | --- | --- | --- | --- || Sherwin-Williams | $192.85 | $384.96 | $2.86 | 0.74% | 1.5% || Microsoft | $151.75 | $443.57 | $3.32 | 0.75% | 2.2% |
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Based on the original investment in each stock five years ago, you would be yielding 1.5% on Sherwin-Williams and 2.2% on Microsoft — significantly higher than the current dividend yields. If you followed the same process, assuming a 10-year investment period, Sherwin-Williams' yield on cost would be 3.4%, and Microsoft's would be a staggering 7%!
2.2%
As a result, your initial investment in both stocks would generate a significant amount of passive income, alongside the profits from the increase in both companies' values.
Fundamental principles to abide by
When investing in dividends, it may be tempting to be captivated by a high yield. While some high-yield stocks can be worth considering if they show signs of improvement, it is crucial to take a step back and focus on the fundamentals of dividend investing. A dividend is only as robust as the company distributing it. Therefore, you should prioritize investing in companies you trust first, and afterward, evaluate their dividend strength.
By maintaining consistency and adhering to these core principles, you can develop a substantial and growing dividend portfolio centered on quality rather than quantity.
In the context of managing your investment portfolio, it's important to consider the impact of dividend payouts on a company's financial health. For instance, consistently allocating all profits to dividends while failing to address debt accumulation could negatively impact the company's long-term growth and market position.
Furthermore, while high dividend yields may attract investors, it's crucial to dive deeper to understand the underlying factors driving the yield. Companies with significant stock price growth, like Walmart and Microsoft, may have low yields due to their increased value, making them potential sources of substantial returns for long-term investors.
