Monday, January 26, 2015

The Power of 5/15 Dividend Growth

As a kid I loved math. Unlike classic literature where I had to correctly interpret symbolism that I rarely ever noticed, math was one of the few subjects that had a definitive answer - it was either right or wrong. I took great comfort in that. Investing in dividend growth stocks takes advantage of certain undeniable math principles.

If you have examined one of my stock analyses, you may have noticed the metric "Rolling 4-yr Div. > 15%". This calculation determines if a company's dividends grew on average in excess of 15% for each consecutive 4-year period, within the last 10 years of history.

For example, if on average dividends grew 15% or more for the periods 2011-2014 and 2010-2013 and 2009-2012 and so on to 2003-2006, then this test is true. The reason I like this metric is it identifies companies that consistently increase dividends significantly. Another way of stating this is that if you held this company for any 4-year period over the last 10 years, you would have averaged a 15% dividend growth rate during the time you held the stock.

Contrast the above example with a company that grew its dividends at 1% per year for nine years, then sold some land in year 10 and paid a special dividend that resulted in a 140% year-over-year dividend increase. This company's average 10-year dividend growth rate is 15% [(140 + 9)/10].

Both companies would have a 15% 10-year average dividend growth rate. However, based on history the first company is more likely to raise its dividend by 15% in the future.

So why is 15% relevant? Dividends will double every 5 years if they grow by 15% per year (5/15). Taking this undeniable math principle into consideration, it often makes sense to purchase a stock with a lower yield but with a higher growth rate. Here are few companies that have the power of 5/15 working for them:

Lockheed Martin Corp. (LMT), the world's largest military weapons manufacturer, is also a significant supplier to NASA and other non-defense government agencies. LMT receives about 93% of its revenues from global defense sales. Yield: 3.1%

Target Corp. (TGT) operates nearly 1,800 Target, SuperTarget and CityTarget general merchandise stores across the U.S. and about 130 stores in Canada. Yield: 2.8%

Microsoft (MSFT), the world's largest software company, develops PC software, including the Windows operating system and the Office application suite. Yield: 2.7% See full analysis here.

Texas Instruments Inc. (TXN) is of the world's largest manufacturers of semiconductors, this company also produces scientific calculator products and DLP products for TVs and video projectors. Yield: 2.6%

Walgreens Boots Alliance, Inc. (WBA) is the largest U.S. retail drug chain in terms of revenues, this company operates more than 8,000 drug stores throughout the U.S. and Puerto Rico. Yield: 1.8%

CVS Health Corporation (CVS) is the largest pharmacy health care provider in the U.S. Yield: 1.4%

If you have time on your side, you should investigate if certain lower yielding stocks with a dividend growth rate fits into your long-term investment strategy. When making this evaluation, it is important to note that the sustainability of the dividend growth rate must be evaluated on a go-forward basis. Like high-yield stocks, there is increasing risk as the dividend growth rises.


Full Disclosure: Long LMT, MSFT, TXN in my Dividend Growth Stocks Portfolio. See a list of all my dividend growth holdings here.

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