Double Your Dividends In Just Six Years

Published in Investing on 10 July 2012

Don't underestimate the power of dividend growth.

Looking for fast-growing dividends? Consider FTSE 100 (UKX) oil services group Petrofac (LSE: PFC), which has boosted its payout by 50.3% over the past five years. Or global brewer SABMiller (LSE: SAB), only slightly behind at a spanking 48.1% five-year dividend growth rate.

Yet income investors are right to be leery of such shares. While the dividend growth may be stellar, the actual starting point -- the dividend yield -- is often low.

In Petrofac's case, the yield is just 2.8%, well below the Footsie's average yield of 3.8%. At SABMiller, it's even lower: 2.5%.

Past performance

Even so, Petrofac and SABMiller provide a handy reminder that investors shouldn't just go out and chase high yields. In short, never assume that two companies offering similar yields are largely the same, dividend‑wise. For long‑term income investors, dividend growth matters as well.

That's because not only do healthy, growing companies often pay out sizable dividends, they also tend to increase those dividends over time.

So when looking at a prospective high-yield investment, ask these three fundamental questions:

  • Has the company a track record of delivering year-on-year increases in its dividend?
  • Better still, has it a record of delivering year-on-year percentage increases in the dividend growth it delivers?
  • Is the dividend amply covered by earnings?

Such companies are a much, much better bet than a business that happens to be offering a high yield simply because its share price has slumped.

Or -- worse -- offering a high yield because investors expect its dividend to be cut, and have consequently driven the share price down. As I wrote last week, the yield trap lurks for the unwary.

Sustainable dividends

That said, high-yield investing can be a judgment call at times, weighing yield against other factors. And undeniably, yields of 9-10% -- as I've written -- are worrying, especially when coupled to low dividend cover.

For me, yields of 5%-6% are far more tempting, speaking as they do to the more likely prospect of being sustained over the longer term. In such cases, it's often short-term worries regarding top-line revenues -- or simply a share falling out of fashion -- that has seen the share price sag, thus raising the yield.

And while the dividend growth posted by such shares may be less than meteoric -- certainly not into Petrofac territory -- it can still deliver a healthy boost over time.

Here, for instance, are three high-yield picks that do the business for me, and which boast an attractive (and sustainable) dividend growth rate as well. And yes, I hold all three.

CompanyToday's priceFive-year dividend growthForecast yield
AstraZeneca (LSE: AZN)2,919p14.9%6.5%
BAE Systems (LSE: BA)307p10.7%6.9%
J. Sainsbury (LSE: SBRY)310p10.6%5.4%

Source: Bloomberg and Digital Look.

Double your money

What's more, the beauty of shares exhibiting dividend growth at these sorts of levels is that you can use the handy 'Rule of 72' to see how long it will take to double your purchase yield.

Take 72 and divide it by the expected growth rate -- 12%, for example, in the case of the average annual dividend growth over these three shares. Divide 72 by 12 and you get 6 -- telling you that it will take roughly six years to double the dividend.

So 15 pence per share today, for instance, will be 30 pence per share in six years' time -- plus, of course, any capital growth delivered through a rising share price. All for sitting back, and being patient.

Which has to be good news.

An expert pick

As it happens, über income-investor Neil Woodford -- who looks after two of the country's largest investment funds, and runs more money for private investors than any other City manager -- counts one of these three shares among his very largest holdings. And he's recently sold a substantial stake in another of these shares' most significant competitor.

A special free report from The Motley Fool -- “8 Shares Held By Britain's Super Investor” -- profiles eight of his largest holdings, and explains the investing logic behind them.

And Mr Woodford, don't forget, provides a powerful example of the devastating effectiveness of buying solidly yielding shares exhibiting decent dividend growth. Over the 15 years to 31 December 2011, on a dividend re‑invested basis, he delivered an impressive 347% return, versus the FTSE All‑Share's distinctly more modest 42% performance. Which to my mind, speaks for itself.

So why not download the report? It's free, so what have you got to lose?

Are you looking to profit from this uncertain economy? "10 Steps To Making A Million In The Market" is the very latest Motley Fool guide to help Britain invest. Better. We urge you to read the report today -- it's free.

More investing ideas from Malcolm Wheatley:

> Malcolm owns shares in AstraZeneca, BAE Systems and Sainsbury. He does not have an interest in any other share mentioned.

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Comments

The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

equitybore 11 Jul 2012 , 10:26am

All commentators point to the value of compounding. So living below your income and re-investing dividends is the quickest way to see dividend growth. I have been particularly happy with a stable of income investment trusts that provide the backbone of my portfolio.

Hannibalis 12 Jul 2012 , 9:44am

Malcolm - I hold those 3 as well. Dividend growth is a Good Thing - and the Rule of 72 is worth repeating but let's not forget that buying a higher yield fixed-income investment than these will give a better return over any medium-term horizon - e.g. SAN, PPR7, EH21. Yes, different risks - but is any UK bank going to go bust now?

http://www.the-diy-income-investor.com/2011/07/high-yield-or-dividend-growth.html

sludgesifter 13 Jul 2012 , 10:34am

Malcolm: Are you considering issues other than dividend-payment history? AstraZeneca will soon plunge over a patent-expiry cliff; BAE Systems is dependent on the defence budgets of over-indebted and fiscally straitened governments desperate to find programmes to cut; and Sainsbury is in head-to-head competition with other major supermarket chains over market share in a consumer sector with little real growth.

alarmbells 13 Jul 2012 , 1:36pm

A good article...

...until, once again and with the tedium that only fool can produce, we reach - yes - Neil Woodford once again.

Pleeeeeeeease, lets' refer to other successful dividend investors.

AChembi 13 Jul 2012 , 2:22pm

My simple assessment on 6 companies (LSE) result the following figures:
From Jan 2010 to July 2012 share prices vary...AZN (+ 1.36%), BA ( - 15%), SBRY ( - 4.7%), TLW ( + 7.2%), DGO ( + 36.8%) and PAF ( + 123%).
Should we go for dividend growth or price movement ?

TimothyUK 13 Jul 2012 , 7:58pm

I have just finished reading "monkey with a pin" and it shows 15% expected earnings are completely unrealistic and actually when you include all the charges you won't make anything like what is proposed here.

FitLawton 14 Jul 2012 , 12:06pm

As important as dividend growth is, do not underestimate the importance of 'start yield' or yoc to long term results: Here's an example:

Assume Stock A has 7% yield and a fixed 2,5% dividend growth p.a.
Stock B has a 3.5% and a fixed 5% dividend growth p.a.

It would take 29 years for Stock B to catch up to the payout level of Stock A, and Stock A wld have generated 73% more cash in that period.

Dividend growth is based on tomorrow's variables, always unknown and changing. Assuming the dividend is sustainable a higher start yield is always more preferable than the promise of tomorrow's growth.

GoldenSoldier 14 Jul 2012 , 1:40pm

FitLawton

“Assuming the dividend is sustainable a higher start yield is always more preferable than the promise of tomorrow's growth”

Sorry, I don’t quite understand this. However, I do agree with the point that I think you are making that past high dividend growth is no guarantee of continued high growth.

johandesilva 15 Jul 2012 , 1:27pm

It would be increasing difficult to beat the track record of VOD and there is nothing much wrong in RSA that yields 9% and then back them up with Shell, GSK and Sainsbury. I would hope this mix would outperform those 3 shares on both growth, yield and safety. But when it comes to big caps I let funds manage these for me because WTFDIK

Right I am going to look at go lose some money in the Falklands and Kurdistan.

dubre 15 Jul 2012 , 6:18pm

"...beat the track record of VOD.."

It depends upon where the track starts.I paid 359p for my Vodafone shares.

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