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%.
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.
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.
|Company||Today's price||Five-year dividend growth||Forecast yield|
|AstraZeneca (LSE: AZN)||2,919p||14.9%||6.5%|
|BAE Systems (LSE: BA)||307p||10.7%||6.9%|
|J. Sainsbury (LSE: SBRY)||310p||10.6%||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?
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> Malcolm owns shares in AstraZeneca, BAE Systems and Sainsbury. He does not have an interest in any other share mentioned.