Juice Your Total Returns And Future Dividend Income Stream With High-Quality, Low-Yielding Stocks (NYSE:TJX) (2024)

Many dividend growth investors tend to focus primarily on blue-chip Dividend Champions that have a history of increasing their annual dividends for at least 25 consecutive years and that have current yields at or above 3%. One reason for this selection focus is to achieve a higher stream of future annual dividend income that results from the compounding effects of dividend growth over time. However, what this article will show is that investment in lower-yielding, high-quality stocks can result in even greater annual dividend income and total returns over just a few years. This article is not suggesting that investors abandon Dividend Aristocrats, but rather it offers a means of diversifying one's stock portfolio and increasing future dividend income and total returns by including both higher-yielding and lower-yielding dividend stocks for the long haul.

The Many Flavors of Dividend Growth Investing

Dividend growth investing is a strategy of building a diverse portfolio of stocks in which the underlying companies have a proven history of paying out and growing their dividends over long periods of time. However, the actual practice of DGI comes in many flavors and combinations, and there is no one correct method or best approach. Indeed, the DGI strategy that individual investors choose to follow can vary greatly and can change over time depending on one's objectives along the various phases of saving and spending for retirement.

For example, some DGIs are primarily concerned about generating current income during retirement, and thus, may tend to focus on higher-yielding, slower-growth stocks and not put much emphasis on capital gains. Whereas others might consider themselves to be total-income investors and like to see both dividend growth and capital gains growth. Some DGIs prefer to invest only in high-quality, blue-chip stocks that have at least a minimum of 25 consecutive years of annual dividend growth (a.k.a., the Dividend Aristocrats or Dividend Champions), while other investors like to focus on up-and-coming dividend growth stocks that could be the next generation of Dividend Aristocrats and Champions (a.k.a., Dividend Challengers and Contenders). Yet another strategy might incorporate a blended or barbell approach to DGI by creating a portfolio consisting of higher-yielding, slower-growing, blue-chip stocks on one side and lower-yielding but faster-growing dividend stocks on the other side. This barbell approach to DGI is the strategy that I personally employ for my own stock portfolios.

An important factor in determining one's DGI strategy is your own personal investment time horizon in relation to when you plan to retire, as well as your penchant for current income versus future income. If you truly have little or no interest in capital gains and primarily want a reliable and growing stream of dividend income from your investments, then focusing on higher-yielding, slower-growth blue-chip stocks, like Johnson & Johnson (JNJ) or AT&T (T), makes sense. Typically, an investor in these higher-yielding blue chips would seek high-quality stocks with annual dividend yields in the 3-5% range, and whose companies increase their dividends at rates above inflation (typical dividend increases are in the low- to high-single digit range for blue chips).

Some investors may venture into even higher-yielding equities, like Real Estate Investment Trusts (REITs), Business Development Companies, or in preferred shares of stocks. There is certainly nothing wrong with this approach as long as one is mindful of not reaching too much for high yield and sacrificing quality. For example, some stocks may be "accidental" high yielders because their underlying fundamentals have weakened, and they may be soon forced to cut their dividend as they can no longer afford to pay it out to shareholders (it is not a good situation for dividends or stock value in such events!).

However, what I want to focus on in this article is investment in high-quality companies that currently have lower yields (closer to 1%), but that have been growing their dividend yields at a double-digit pace, and that have also shown strong earnings growth, resulting in higher capital gains and total returns. Indeed, strong earnings growth is a key factor in determining the valuation of a company, and thus, its stock price. And since dividend yield is simply determined by dividing the annual distribution per share by the stock price, then it is not surprising that a company can seem to perpetually have a low yield even though it grows its dividend at a high rate.

TJX Companies: A High-Quality, Low-Yielding Stock with Double-Digit Dividend Growth

One of my favorite low-yielding, faster-growing stocks is TJX Companies (NYSE:TJX), which I initially recommended to Seeking Alpha readers in 2014. TJX is the leading off-price apparel and home fashions retailer in the U.S. and worldwide, and in contrast to other slumping retailers, is firing on all cylinders and appears to be Amazon (AMZN)-proof.

TJX has grown its dividend at a compound annual rate of 23% per year for 21 consecutive years. Yet, the stock rarely yields much above 1%, as the price has risen to match the earnings growth (i.e., TJX is also distinguished by an impressive 21 consecutive years of comparable store sales increases). This outstanding level of earnings performance by TJX is clearly reflected in the share price and total return price of the stock as compared to the S&P 500 over the past 20 years (Figure 1). Figure 2 illustrates how the share price has risen over time in relative lock-step with the generous dividend increases, which has served to keep the dividend at a relatively constant forward yield of slightly more than 1%. A company can't continue to increase its dividends at a >20% clip without also either increasing its earnings, increasing its payout ratio or going into debt. Remarkably, TJX has managed to keep its payout ratio (dividends per share / earnings per share) under 30% for the past decade. This suggests the company has plenty of room to continue comfortably increasing its dividend for years to come.

Figure 1: The market has recognized TJX's 21 consecutive years of comparable-store sales increases, as the stock price has risen 2,700% over the past 20 years, with total returns (dividends reinvested) climbing to over 3,300%. Over the same time period, the S&P 500's share price has risen 224% and total returns 373%. Source: YCharts

Figure 2: TJX has raised its dividend at annual compound rate of 23% per year for 21 consecutive years. The share price (blue line) has generally increased over time to match the rising dividend payout (orange line) and earnings of TJX Companies. This rising share price has resulted in relatively constant forward yield of a bit more than 1%. Source: YCharts

Low Yield, High Growth, and the Power of Compounding

Investors who tend to focus on higher-yielding stocks without regard to capital gains or total returns would not likely be impressed with the charts above or with such measly yielding stocks like TJX that barely have an annual forward yield over 1%. However, if one is not interested in current income and has time to let dividends compound on initial investment cost, then lower-yielding, higher-growth stocks can pack a very powerful punch over the long term, and perhaps more importantly, can generate greater annual income over time than higher-yielding blue chips. Let me demonstrate by comparing TJX, a low-yield, higher-growth stock, with two blue-chip stalwarts, Johnson & Johnson and AT&T, which are both favorites among income investors.

Johnson & Johnson and AT&T are both Dividend Aristocrats/Champions (at least 25 consecutive years of dividend increases), with JNJ having increased its dividend for 54 consecutive years and T having increased its dividend for 33 consecutive years. By contrast, TJX has not quite reached the illustrious recognition of a Dividend Champion, but is well on its way to such distinction with 21 consecutive years of dividend increases (making it a "Dividend Contender" according to David Fish's excellent spreadsheet of Dividend Champions, Contenders, and Challengers). In terms of stock price and total return performance, TJX has clearly outperformed both JNJ and T over the past 10 years, as illustrated in the two charts below (Figure 3).

Figure 3: TJX has substantially outperformed both JNJ and T in stock price increase and total returns over the past 10 years. Source: YCharts

Increases in stock price and total returns may be impressive to some, but what about income? Surely, a stock like TJX yielding only a bit more than 1% can't possibly result in more annual income than higher-yielding stocks like JNJ or T, which historically have had yields closer to 3% and 5%, respectively. And that assessment would be correct if we were talking only about forward yield, or the yield at which you were to purchase the stock at today, based on the current annual dividend payment, and you were not considering the future dividend growth rates over time. For example, if one has time to purchase a stock and let the dividend growth compound over time (regardless of whether dividends are reinvested or not), then one can see how the power of compounding can result in higher annual income for lower-yielding, higher-growth stocks like TJX.

Watch as a Lower-Yielding Stock Out-Yields Higher-Yielding Stocks

For this demonstration, we'll go back in time and pretend we purchased $10,000 worth of stock for each of TJX, JNJ, and T at their respective closing prices on December 29, 2006, which was the last day the market was open that year. Table 1 below shows the closing purchase prices where we purchased each stock, the number of shares of each stock we could purchase for ten grand, and the dividend yield at the time of purchase. Note that TJX was yielding just under 1% at our purchase price, while JNJ were yielding more than double (2.21%) and triple (3.72%) that of TJX, respectively.

Table 1: Share prices at market close on December 29, 2006, and the number of shares $10,000 would have purchased of each stock. Annual dividends and forward yields at time of purchase are listed in the last two columns. Source of data: Morningstar

Table 2 below shows the annual income received for TJX, JNJ, and T for each of the past 10 years on the shares we purchased. It also shows the annual dividend increase (dollars/share) each year for all three stocks and the year-end dividend yields. Note that JNJ had typical year-end dividend yields ranging between 2.43% and 3.43% over the past 10 years, while T had year-end yields that ranged from 3.42% to nearly 5.85%. Both JNJ and T continued to increase their annual dividends at rates ranging from single-to-double digits. In contrast to those higher yields, TJX had yields that ranged from 0.98% to 2.04%, but also increased its dividend rates by greater than 20% in every year except 2009, in which the dividend was still increased by an impressive 14.29%. Note that all three companies continued to increase their dividends during the great recession in 2009.

Table 2: Annual dividends paid out by TJX, JNJ, and T based on a $10,000 initial investment for each company at the December 31, 2006, closing prices. Orange cells indicate years that JNJ and T begin to pay out less income than TJX, even though the annual yield is much lower for TJX. Due to the effects of compounding dividend increases on the initial investment, the yield on cost for TJX is now greater than for JNJ and T, although the forward yield is lower. Yield on cost after 10 years: TJX = 6.94%; JNJ = 4.77%; T = 5.37%. Source of data: Morningstar

Regarding income from the dividends, note that both JNJ and T would have immediately provided a higher level of dividend income on the initial stock purchase, and would have continued to do so for the majority of the time period shown. This is due to the higher starting, or forward yields of JNJ and T. However, look what happens in years 2014-2016 for TJX (green shaded cells). Eight years after the initial purchase, TJX is now paying out a higher dividend income than JNJ, and TJX eclipses T's dividend income beginning in 2015. These data illustrate how a low-yielding, but faster-growing stock can surpass a higher-yielding, slower-growing stock given enough time for the dividends to both grow at a faster rate and to compound on one's initial investment cost.

What these results demonstrate is that even though TJX's forward dividend never varies much above a 1% yield, over time, due to TJX's higher dividend growth rate that was compounded on the number of shares originally purchased, the annual dividend income grew at a faster rate and surpassed the annual income of JNJ and T within a few years. Figure 4 below illustrates how TJX's income was able to surpass that of higher forward-yielding JNJ and T, which was the result of a much greater dividend compound annual growth rate (or CAGR), for TJX. The dividend CAGR for TJX was nearly 22% over the past 10 years, while the CAGR for JNJ (7.99%) and T (3.74%) was in the single digits.

Figure 4: Despite a much lower starting yield at purchase, TJX was able to surpass the annual income payout of TJX and T, due to the much greater compound annual growth rate of the dividend distribution. Source of data: Morningstar

Figure 5: The top panel above shows the initial yield at purchase (forward yield) for TJX, JNJ, and T, and the subsequent yield on cost 10 years later ($10,000 initial investment for each stock). The greater dividend CAGR for TJX results in an eventual higher yield on cost and greater annual income over time (bottom panel). Source of data: Morningstar

Why Yield on Cost is an Important Consideration for Buy-and-Hold Dividend Growth Investors

Yield on cost is an investment's annual dividend divided by the original purchase price of the investment (or on the cost basis if dividends are reinvested). This is different from current or forward yield in which the current annual dividend is divided by the current stock price. In looking for dividend-paying stocks to invest in, many investors tend to overlook lower-yielding stocks in favor of higher, current yielders. But in doing so, they may limit their potential longer-term total returns and annual income stream by not taking into account a lower-yielding company's potential for growing its dividends at a faster rate. A faster dividend growth rate will result in a higher yield on cost after a period of years, due to higher compound growth of the dividend distribution. For example, simply picking Stock A because it yields 5% today over Stock B, which yields only 1% today, ignores the growth potential of both stocks. Factors that one should consider in addition to current yield include the quality of the company, management's commitment to returning earnings to shareholders, the historical dividend growth of the company, the payout ratio (proportion of earnings paid to investors as dividends), and the future earnings potential of the company (greater earnings potential = greater potential for higher dividend growth).

I frequently read comments on Seeking Alpha by commenters stating that they would never buy stocks of companies like TJX, Starbucks (SBUX), Walt Disney (DIS), or Home Depot (HD), to name a few, simply because their yields are too low. Now that may be a fine reason if one is currently retired and only seeking current income. However, for younger investors with long-investment horizons (or even current retirees who may yet still have 30 or more years of retirement left), dividend growth rates and how those affect yield on cost should be an important consideration, and as I've shown above, can result in higher annual income over time than higher-yielding, slower-growth stocks.

Some Low-Yielding, High-Quality Stocks for Your Consideration

Below I've listed several high-quality stocks with current low dividend yields, but that have a history of double-digit dividend growth rates. To make the cut in terms of quality, the stocks below had to have a solid credit rating (B+ or higher as rated by S&P Capital IQ and Value Line), a "Safety" rating of 1 or 2 by Value Line (indicating greater stability and less risk to principal), and "Stewardship" ratings by Morningstar of either "Standard" or "Exemplary" (ratings of company management). In addition, I only invest in stocks that have demonstrated economic moats, as coined by Warren Buffett, to indicate companies with significant competitive advantages over competitors. Morningstar provides such economic moat ratings, and all the stocks below have at minimum a "Narrow" moat rating to a "Wide" moat rating.

For each company listed, I also provided some information regarding its underlying fundamentals, including earnings and net income growth, payout ratio, 10-year dividend CAGR, and the current Morningstar fair value estimates. Note each of these low-yielding stocks has a solid 10-year history of earnings growth, very modest payout ratio (indicating ample room for future dividend hikes), and a solid history of double-digit dividend growth. Unfortunately, due to the market currently trading around all-time highs, most of the companies listed are above Morningstar's fair value estimate. I personally prefer to buy stocks that are at least 10% below their FVE. Two of the stocks listed - DIS and SBUX - are currently below the Morningstar FVE, and are worth consideration for long-term investors. Both TJX and HD are currently firing on all cylinders, and it may be very difficult to get those stocks below their FVE unless there is a major market correction. Note that TJX, HD, and SBUX all recently raised their dividends by 20% or more.

Table 3: Some high-quality, low-yielding stocks with strong dividend growth potential for consideration. All of the stocks listed have a minimum of 10 years of double-digit dividend compound annual growth rates, except Comcast (CMCSA) and SBUX, which did not start paying dividends until 2008 and 2010, respectively (indicated by an *). Source of data: Morningstar, S&P Capital IQ, and Value Line

Summary

I hope this article has demonstrated how purchasing high-quality, low-yielding stocks can potentially result in greater total returns and higher annual income from dividends over time as compared to higher-yielding, but slower-growth stocks. While the concept of greater income from low-yielding stocks may at first seem counterintuitive, once one considers such important fundamentals as earnings growth, the historical and future potential dividend growth rates, and the effects of compounding dividend growth, the value of adding low-yielding stocks to one's portfolio for greater income growth becomes clear.

This article was in no way meant as an attempt to persuade investors from purchasing classic, high-yielding blue chips, but rather to potentially broaden the landscape of available stocks and to help dividend growth investors achieve their ultimate goal of an ever-increasing stream of annual income to beat inflation and help provide for a sound retirement. In this regard, adding low-yielding stocks to a blue-chip portfolio is a great way to augment one's income portfolio by increasing both income (over time) and total returns growth. Thus, one can think of this as a barbell investing strategy, with classic high-yielding blue chips one side of the bar and lower-yielding, but faster-growing stocks on the other side. How much weight one chooses to add to either side of the bar is completely up to the individual and their investment horizon. I'd suggest a combination of both during any investment period, but with perhaps a larger focus on low-yielding stocks while one is younger and accumulating wealth (to allow for longer periods of dividend compounding) and perhaps a larger allocation to higher-yielding blue chips as one nears retirement or while in retirement.

Minutemen