In my piece last week I showed how a simple screen might be a useful tool to find sustainable high yield stocks in the FTSE 350.
This week I want to approach income from the perspective of strong growth rather than yield. So I’ve created an alternative screen that looks for stocks with strong dividend growth characteristics.
Why would I consider this approach? For me, dividend growth investments fall into two possible categories (sometimes both):
Quality growth stocks: rapid, well-supported dividend growth can be an indicator of a small/mid-cap quality business that’s growing fast. In this scenario, the company’s share price will often rise at a similar or even greater rate than its dividend.
Contemporary examples of this might include Tatton Asset Management (LON:TAM) or Jet2 (LON:JET2). These companies have five-year average dividend growth rates of 13.8% and 7.6% respectively. Both have been multibaggers over the last 10 years:
Cash multibaggers: over longer periods, successful dividend growth investments can reach a point where the cash income received from the shares exceeds the original investment.
In other words, the investment will deliver multibagger returns in cash, not just through share price gains.
The most famous example of this is probably Warren Buffett’s stake in Coca-Cola Co (NYQ:KO). Buffett’s company Berkshire Hathaway owns 400m shares that originally cost the firm about $1.3bn. That’s equivalent to an average cost price of about $3.25 per share.
Coca-Cola’s dividend currently stands at $1.89 per share, according to Stockopedia. That gives Buffett’s shares a yield on cost of 58%.
In other words, Berkshire Hathaway doubles its original Coca-Cola investment in cash income alone every two years. That’s without factoring in share price growth:
A word of warning! Warren Buffett has owned Coca-Cola shares since the dawn of time 1988. Investing in potential dividend compounders is a long-term strategy that is only likely to work well with high quality businesses. Essentially, this is an income variation of the compounding quality approach.
Over shorter periods, the income received from dividend growth stocks may be significantly less than the cash payouts from sluggish high yielders.
I’ll return to this theme in the final article of this series, when I’ll consider some of the…
