10 stocks that not only beat the S&P 500 but also grew their dividends the most

By Philip van Doorn

A strategy of growing dividend income over time might be better than focusing on high current yields

Patient long-term investors can build up high streams of dividend income if they focus less on high current yields and more on quality.

Some investors look for stocks that have high dividend yields because they want the dividend income right now. But a strategy of building up dividend income over the long haul might serve you better.

One problem when seeking high current dividend yields on stocks is that you can fall into a "value trap." A stock's dividend yield may be high because its price has declined as investors have foreseen a dividend cut. Companies can lower their dividend payouts for various reasons. For stocks with the highest current dividend yields, the writing is typically on the wall: Expect dividend cuts.

What about stocks with more modest, but still significant, dividend yields? These dividends are likely to be well supported by the companies' cash flow and the payouts might increase steadily over the years, leading to a compounding effect for income streams.

A dividend compounding example

Here is a company that scored high on a five-year screen of the S&P 500 for dividend compounders:

-- If you had purchased Morgan Stanley's stock MS at the close on Sept. 30, 2020, you would have paid $48.35 a share. At that time, the company was paying a quarterly dividend of 35 cents a share, for an annual payout of $1.40. The dividend yield at that time was 2.90%. That may not seem to be such an attractive yield, but at that time, the Federal Open Market Committee's target range for the federal-funds rate was zero to 0.25%. Bank accounts were paying next to nothing. The current federal-funds target range is 4% to 4.25%, after the FOMC lowered short-term interest rates by a quarter-point last month. More cuts can be expected as the U.S. labor market deteriorates.

-- If you had held your Morgan Stanley stock for five years, your quarterly dividend would have increased to a dollar a share. The current yield, based on Tuesday's closing price of $158.96, would be 2.52%. That is what the yield would be for a new investor. But your dividend yield on your five-year-old shares, based on what you paid for them, would be 8.27%. Meanwhile, the share price more than tripled. If you had reinvested your dividends, your five-year total return would have been 286%.

So one can say that Morgan Stanley's dividend yield is lower now than it was five years ago, but that only applies to investors buying the stock today. And even the current yield of 2.52% is attractive for an investment bank whose overall performance has been strong for years as it has executed a strategy of growing its asset-management business. This is a lucrative business line that steadies financial performance, as investment banking is more cyclical.

These are only snapshots, and an investment bank's total revenue can fluctuate significantly through cycles for trading income and activities such as stock and bond underwriting. But during the second quarter, Morgan Stanley booked $4.41 billion in asset-management revenue, which made up 57% of its total net revenue of $7.76 billion. Five years earlier, asset-management revenue made up 54% of net revenue, while 10 years earlier, combined revenues for what were then categorized as wealth management and investment management made up 47% of net revenue.

Asset management is a lucrative business. Morgan Stanley said the pretax margin for this unit was 28.3% during the second quarter.

This is the type of research you can and should do yourself if you are interested in a company and want to learn more about its business strategy. All of this information was included in Morgan Stanley's earnings releases, with more detail in subsequent 10-Q and 10-K filings with the Securities and Exchange Commission.

Stock screen: S&P 500 dividend compounders

Starting with the current components of the S&P 500 SPX, we looked back five years to see that at that time, 247 of these stocks had dividend yields of at least 1.50%. So that was our starting point.

Among these 247 companies, 246 are still paying dividends. The exception is Intel Corp. (INTC), which suspended its dividend during the fourth quarter last year.

We looked at five-year compound annual growth rates for the remaining 246 companies, based on current annual dividend rates and those as of Sept. 30, 2020, based on data provided by FactSet.

These 10 companies have had the highest five-year dividend CAGR:

   Company                    Ticker   5-year dividend CAGR  Dividend yield on shares purchased 5 years ago  Dividend yield 5 years ago  Current yield  5-year price change  5-year total return 
   Targa Resources Corp.     TRGP                    58.49%                                          28.51%                       2.85%          2.39%               1,094%               1,219% 
   Wells Fargo & Co.         WFC                     35.10%                                           7.66%                       1.70%          2.15%                 257%                 300% 
   Goldman Sachs Group Inc.  GS                      26.19%                                           7.96%                       2.49%          2.01%                 296%                 346% 
   Morgan Stanley            MS                      23.36%                                           8.27%                       2.90%          2.52%                 229%                 286% 
   Williams-Sonoma Inc.      WSM                     22.42%                                           5.84%                       2.12%          1.35%                 332%                 377% 
   EOG Resources Inc.        EOG                     22.16%                                          11.35%                       4.17%          3.64%                 212%                 298% 
   Diamondback Energy Inc.   FANG                    21.67%                                          13.28%                       4.98%          2.80%                 375%                 490% 
   Darden Restaurants Inc.   DRI                     20.52%                                           5.96%                       2.34%          3.15%                  89%                 120% 
   Kimco Realty Corp.        KIM                     20.11%                                           8.88%                       3.55%          4.58%                  94%                 140% 
   Schlumberger Ltd.         SLB                     17.92%                                           7.33%                       3.21%          3.32%                 121%                 146% 
                                                                                                                                                                                 Source: FactSet 

There is a lot of data on the table, and you may need to scroll the table or flip your screen to landscape to see all of the columns, depending on what device you are using.

To the right of the dividend CAGR column are dividend yields for investors who had held each stock for five years. Then there are the yields five years ago and the current dividend yields for new investors. The right-most columns show price increases and total returns with dividends reinvested. On that basis, all 10 stocks beat the S&P 500's 10-year return of 114%.

As mentioned above, you should do your own research to form your own opinion about the business strategy and long-term prospects for any individual company you are considering for investment.

One way to begin that process is to click on the tickers for more information.

Read: Tomi Kilgore's detailed guide to the information available on the MarketWatch quote page

Don't miss: Two stock picks for long-term growth as people keep moving away from cash

-Philip van Doorn

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10-02-25 0958ET