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Many dividend investors are focused on owning stocks that have a 3% yield. There are a number of great companies that have 3% yields. However, many of them also have below average earnings growth. The below average earnings growth is likely to cause the stocks to underperform or merely match the performance of the S&P 500.
For example, great companies like Coca Cola (NYSE:KO) and Merck & Company (NYSE:MRK) have good dividend yields of at least 3%, but their expected earnings growth falls below the expected earnings growth for the S&P 500, which is expected to be 5% to 6% annually for the next five years. Coca Cola and Merck are expected to average 3% and 4% annual earnings growth over the next five years respectively. This below average growth could cause the stocks to underperform the S&P 500 over the next five years.
I'm not saying that investors who own these types of stocks should sell them and replace them with higher growth dividend payers. Coca Cola and Merck are diverse companies that are likely to be steady growers over the long-term. I am writing this article to provide investors with another way of thinking about dividend investing and to get alternate ideas for stocks that could be added to an existing dividend portfolio.
Companies with above average growth typically have lower dividend yields. The above average price appreciation associated with these stocks typically makes up for the lower yields. The total yield [dividends plus price appreciation] is likely to be higher over the long-term for the higher growth dividend yielders. So, if you are a Millennial or a Generation Xer, then you'll most likely gain more over the long-term with the higher growth dividend payers. Retirees and Baby Boomers can also own some of these, but they will probably want the higher dividend yielders for income generation.
The companies that I'm looking at have above average earnings growth, which is driving their stock prices to outperform the market. This outperformance makes up for their lower dividend yields. Therefore, if you look at the total gain (dividends plus price appreciation), the higher growth dividend companies are likely to outperform the higher yielding lower growth companies over the long-term. The lower growth companies like Coca Cola and Merck may offer a total annual gain of about 6% to 7% (3% dividend yield + plus price appreciation based on earnings growth). However, the higher growth dividend stocks that I will discuss are likely to produce total gains that exceed 15%. The higher gains are likely to be driven by the higher earnings growth that these companies are expected to achieve.
One example of a high growth dividend payer is Home Depot (NYSE:HD). Although the dividend yield is low at 1.78%, the company's high earnings growth drove the stock to outperform the S&P 500 over the past 5 years. Looking forward, consensus estimates show that Home Depot is expected to grow earnings at an average of 14% to 15% annually over the next five years. This high earnings growth is likely to lead to above average price appreciation for the stock. If you add the dividend of 1.78%, investors have the potential of achieving total gains of 15% to 17% annually (dividend yield plus price appreciation based on earnings growth).
Home Depot is likely to hit its earnings targets due to the improving economy. The recent jobs number for December revealed a 292,000 gain in new non-farm payrolls, keeping the unemployment rate at 5%. This was 39% higher than the 210,000 estimate from Wall Street Journal economists. The latest report on sales of new single-family houses showed an increase of 9.1% for November 2015 over November 2014. Home Depot is likely to benefit from this strength as consumers purchase appliances and other home-related items for their new houses. Home Depot has achieved consistent single-digit increases in comp store sales in recent quarters. I think that this will continue going forward as consumers improve their existing homes and as owners of new homes buy appliances.
Another high growth dividend payer is Visa (NYSE:V). The company has a low dividend yield of 0.72%, but the strength of the underlying business drives above average earnings growth. This is another stock that has significantly outperformed the S&P 500 over the past five years. Visa is expected to average 16% annual earnings growth over the next five years according to consensus estimates. This is likely to be achieved since the company collects fees for whatever is purchased with its credit cards. I would expect the stock to continue to outperform the S&P 500 as it continues to grow earnings at an above average pace.
Visa has the advantage of being the largest retail electronic payments network based on payments volume, total volume, and number of transactions. The company operates in over 200 countries, which is a huge footprint that provides Visa with ongoing repeat business. Visa gets involved with new technologies such as Apple Pay (NASDAQ:AAPL) Google Wallet (NASDAQ:GOOG) (NASDAQ:GOOGL), and Square (NYSE:SQ), so it is able to earn fees for these transactions. The company has a good knack for achieving growth by increasing transactions globally. Investors can expect approximate total annual gains of about 16% to 17% based on dividends plus price appreciation driven by earnings growth.
Conclusion
The traditional companies that are a part of a dividend growth strategy typically do have higher yields than the higher growth dividend payers. The traditional dividend companies usually have steady growth and cash flow, leading to steady dividend increases. However, consider some high growth dividend stocks as part of your dividend growth strategy. Companies like Home Depot and Visa that are growing earnings at above average rates are more likely to experience higher stock appreciation which will make up for their lower dividend yields. Furthermore, the strong growth nature of these companies makes it likely that dividend payments will be increased going forward. The total gain (dividends plus price appreciation) for investors is likely to be higher for the higher growth dividend payers over the long-term. Therefore, if you have ten or more years until retirement, a few of the high growth dividend payers will be good to own to grow wealth over time.
David Zanoni
David focuses on growth & momentum stocks that are reasonably priced and likely to outperform the market over the long-term. He is a long term investor of quality stocks and uses options for strategy. David told investors to buy in March 2009 at the bottom of the financial crisis. The S&P 500 increased 367% and the Nasdaq increased 685% from 2009 through 2019. He wants to help make people money by investing in high-quality growth stocks.
Analyst’s Disclosure: I am/we are long V, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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