Why income hunters should go for dividend compounders over high-yielding stocks

By Philip van Doorn

Companies in the S&P 500 that have increased their payouts the most tend to be strong overall performers

An investor who needs income right now has an advantage - short-term interest rates remain high and you can easily get a yield of 5% with no risk with a bank CD (if you are below deposit insurance limits). It is even common to earn more than 4% in a savings account, with immediate access to your money. But interest rates aren't always this high. Only two years ago banks were paying next to nothing for savings accounts and CD yields were also very low.

If your long-term goal is to build a retirement nest egg and eventually draw income from it, a good strategy for part of your portfolio might be to hold stocks of dividend-paying companies that have a record of raising their payouts significantly over time.

If you look at stocks that have high current dividend yields, some of those yields are really warnings built into the share prices. The yields are high because enough investors expect dividend cuts that the stocks are trading at relatively low valuations. If we look at the 20 stocks in the S&P 500 SPX that had the highest dividend yields 20 years ago, 14 have underperformed the index on a total-return basis, with dividends reinvested. And that excludes companies that may have dropped out of the index because of declining market valuations or for other reasons.

So today we are screening the S&P 500 for companies that have increased their dividends the most over the past five years. The yields five years ago didn't need to be high for the best dividend compounders to show good overall results, with a strong tendency to beat the index's total return.

For example:

If you had bought shares of Goldman Sachs five years ago, you would have paid $191.67 a share if you went in at the close on Feb. 8, 2019. At that time, the company's quarterly dividend was 80 cents a share, for an annual dividend rate of $3.20. So the dividend yield on that day was 1.67%.If you had held your Goldman Sachs shares for five years through Thursday, your quarterly dividend would have increased to $2.75 a share, for a current annual payout of $11. The company's dividend has increased at a compound annual growth rate (CAGR) of 28.01% over the past five years. In comparison, the S&P 500's weighted dividend rate has increased at an estimated CAGR of 6.16% over the past five years, according to FactSet.That annual payout rate of $11 would make for a current dividend yield of 2.86% for a new investor who bought Goldmans's shares for $385.04 at Thursday's close. But if you had held Goldman's stock purchased five years earlier, the yield on your five-year-old shares (based on what you paid for them) would be 5.74%. And your share price would have doubled. And if you had reinvested your dividends, your total return for the five years would have been 126%, compared with a 101% return for the S&P 500 SPX during that period.

Screening the S&P 500 for dividend compounders

For a new screen of dividend compounders, we began with the S&P 500 and narrowed the group to 281 stocks with dividend yields that were at least 1.5% as of Feb. 8, 2019.

Among those 281 companies, these 20 have had the highest dividend CAGR over the past five years. See the notes below the table for important information.

   Company                        Ticker   Five-year dividend CAGR  Dividend yield on shares purchased five years ago  Dividend yield five years ago  Current dividend yield  Five-year price change  Five-year total return 
   Goldman Sachs Group Inc.         GS                      28.01%                                              5.74%                          1.67%                   2.86%                    101%                    126% 
   Freeport-McMoRan Inc.           FCX                      24.57%                                              5.17%                          1.72%                   1.57%                    228%                    248% 
   Newmont Corp.                   NEM                      23.36%                                              4.73%                          1.65%                   4.80%                     -1%                     17% 
   Morgan Stanley                   MS                      23.16%                                              8.33%                          2.94%                   3.97%                    110%                    145% 
   Microchip Technology Inc.       MCHP                     19.78%                                              4.12%                          1.67%                   2.13%                     93%                    109% 
   Lowe's Cos. Inc.                LOW                      18.04%                                              4.53%                          1.98%                   2.00%                    127%                    148% 
   Steel Dynamics Inc.             STLD                     17.78%                                              4.75%                          2.10%                   1.36%                    249%                    292% 
   Invitation Homes Inc.           INVH                     16.59%                                              4.91%                          2.28%                   3.43%                     43%                     62% 
   Kroger Co.                       KR                      15.68%                                              4.17%                          2.01%                   2.55%                     63%                     82% 
   Best Buy Co. Inc.               BBY                      15.38%                                              6.24%                          3.05%                   4.87%                     28%                     52% 
   Home Depot Inc.                  HD                      15.20%                                              4.53%                          2.23%                   2.30%                     97%                    123% 
   Eli Lilly and Co.               LLY                      15.05%                                              4.35%                          2.16%                   0.71%                    515%                    567% 
   D.R. Horton Inc.                DHI                      14.87%                                              3.18%                          1.59%                   0.83%                    283%                    304% 
   Raymond James Financial Inc.    RJF                      14.70%                                              3.36%                          1.69%                   1.61%                    109%                    127% 
   Broadcom Inc.                   AVGO                     14.65%                                              7.66%                          3.87%                   1.65%                    365%                    449% 
   Snap-on Inc.                    SNA                      14.38%                                              4.86%                          2.48%                   2.80%                     74%                     98% 
   Parker-Hannifin Corp.            PH                      14.26%                                              3.65%                          1.88%                   1.15%                    218%                    245% 
   Deere & Co.                      DE                      14.10%                                              3.61%                          1.87%                   1.52%                    137%                    155% 
   KLA Corp.                       KLAC                     14.09%                                              5.49%                          2.84%                   0.94%                    486%                    534% 
   American Tower Corp.            AMT                      13.93%                                              3.74%                          1.95%                   3.33%                     12%                     26% 
                                                                                                                                                                                                             Source: FactSet 

Click on the tickers for more about each company.

Share prices and annual dividend rates have been adjusted by FactSet for any stock splits.

Most of the dividends paid by these companies are regular quarterly dividends. But Freeport-McMoRan Inc. (FCX) currently pays a quarterly "base" dividend of 7.5 cents a share, plus a performance-based payout, based on available cash flow according to criteria set forth at the bottom of page 11 of its Jan. 24 earnings press release. The most recent performance-based payout was 7.5 cents for a quarterly dividend of 15 cents and the annual payout rate of 60 cents reflected in the yields on the table above.

For Newmont Corp. (NEM), the quarterly payout is based on spot prices for gold and on the company's financial results. In February 2023, the company said it expected to pay total regular dividends of a dollar a share annually, based on its "reserves gold pricing assumption" of $1,400 an ounce for 2023. Continuous front-month contracts for gold on the New York Mercantile Exchange (CL00) fluctuated between $1,810.80 and $2,152.30 last year. It traded for $2,046.30 early Friday. On top of the base quarterly payout of 25 cents a share, the company paid an additional 15 cents for a quarterly dividend of 40 cents over the past four quarters for the annual dividend rate of $1.60 reflected in the yields on the table above. But in 2022, the quarterly dividend rate was 55 cents and the annual rate was $2.20.

Newmont is scheduled to announce its fourth-quarter results on Feb. 22 and at that time should establish the payout range for dividends this year.

Fourteen of these 20 companies have beaten the S&P 500's 101% over the past five years. Snap-on Inc. (SNA) just missed that distinction, with a five-year return of 98%.

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02-10-24 0534ET

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