Dividend Growth Stocks: The Hidden Power

Dividend Growth Stocks

Dividend growth stocks are stocks that pay increasing dividends over time.

There is a misconception among investors that dividend stocks are boring and have low ROI. In this article, we would like to present how investing in dividend stocks can be rewarding investments.

Dividend growth stocks chart
This chart is an example of a dividend growth stock. We can see that the dividend yield and dividend payout grew consistently over the past ten years. The stock price also appreciated giving an additional capital gain on top of the dividend payout.

 

Dividend Growth Stocks Explained

You may be aware of the metric called the dividend yield. The dividend yield is the percentage of dividend payout you receive by owning a single stock. The simple formula is as follows:

Dividend yield = dividend payout / stock price

Let us assume you are buying a Starbucks stock for $5. This Starbucks stock yields a 2% dividend at the time of purchase. Let us say you bought 1000 units. If you calculate the number, you earn a dividend payout of 2% * $5 * 1,000 = $100 per year. Well, that is not that impressive.

Let us assume you stay the course and keep holding this Starbucks stock for the next 20 years. After 20 years, one Starbucks stock is worth $105. Now you have $105,000 worth of Starbucks stocks. That is already a massive capital gain. Let us say Starbucks still pays a dividend yield of 2%. Now let us calculate how much you will earn per year from your stock holdings: 2% * $105 * 1,000 = $2,100 per year. That is impressive, considering you only invested $5,000 initially. There should be inflation considerations here, but you will still do very well with that investment.

If you calculate the dividend yield: by investing $5 with a 2% yield, after 20 years, your dividend yield will become $2.1 / $5 * 100% = 42%. Your 2% dividend yield becomes 42% if you hold it for the long term. In other words, although the current dividend yield is 2%, the future value will be 42% if you invest in a stock with a similar performance as above.

Mind blown

This is the hidden power of dividend growth stocks that most people do not realize.

A key consideration here is to choose dividend stocks that you believe will increase their dividend payout consistently over the long term. If you find them, you can experience the power of dividend growth. You can reinvest the dividend payouts for an even more powerful compounding effect.

 

Which dividend stocks?

Good question. The usual concern with companies that pay dividends is that they are already mature enough and no longer growing their business. Therefore, the profit is distributed as a dividend to the shareholders. Because we want to invest for the long term, we want to ensure we invest in a company that will still be around 10-20 years from now (or depending on your investment horizon).

Business Lifecycle Stages

A typical business cycle starts with the introduction stage > growth stage > maturity stage > decline stage. Dividend stocks typically belong to companies in the late growth, maturity, and decline stage. Because we want to invest long-term, we should look at dividend-paying companies in the growth and maturity stages. These stages usually allow the companies to pay and increase dividends over time.

To get started, look at some of the longest-paying dividend stocks with a consistent track record of increasing their dividends over the years. They are called the Dividend Aristocrats. Although the dividend aristocrat list gives you a starting point for finding the dividend growth stocks that fit your investment objective, only some will fulfill your criteria. Please do your research first before investing for the long term.

 

Summary

Dividend investing is often perceived as boring, but the ROI may be more exciting than you think. Investing in the top-performing dividend stocks has returned a competitive performance compared to the S&P500 index, with lower volatility. It is a viable investment strategy based on your investment objective.

Dividend Aristocrats Performance
The chart above shows the 10-year historical performance between the top dividend stocks vs the overall market index (S&P500). Based on historical data, dividend stocks can provide competitive performance with less price volatility.
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Disclaimer: The information provided here is not intended to be and does not constitute financial advice, investment advice, trading advice, or any other advice or recommendation of any sort.

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David Ang

About David Ang

A long-term investor with a portfolio across the United States and Asian equities, REITs, commodities, and fixed incomes. After over a decade of hands-on investing (and making countless mistakes), I'm excited to use this platform to share what I've learned over the years. And let's continue to learn together. Writing about macro economy, equities, personal finance, web3. Follow me on Twitter: @danggaku