Wall Street's Best Kept Secret

Many investors view companies with the highest yields as the best investments. You can't blame those who want to maximize their income, but this thirst for yield tends to make you forget the total profitability and inflation. If you talk about companies that have been increasing their dividends for 50 consecutive years, you will see blank looks around you. Many people wonder how a company could increase its dividends every year for several decades, when their yield is only 3%.

In order to understand the dividend growth strategy, it is necessary to go back to basics. The yield of a stock is calculated by annualizing the last dividend and dividing it by the stock price. Let's see for example Johnson & Johnson (JNJ): the dividend is 61 cents per share, the latter trading at 68.3 $. The annualized dividend is therefore $ 2.44/share, or a yield of 3.50%.

The yield on purchase cost is calculated by dividing the last annual dividend by the price you paid for the shares you own. If you bought Johnson & Johnson In the late '90s, when the stock was trading at $ 8.97 and the annual dividend was 17 cents, your yield would have been 1.90%. Your yield on cost would also have been 1.90%. This was an especially low yield, considering that 30-year Treasuries were yielding you 8.25% and the S&P 500 yielded 3.74%.

The company has been able to grow its earnings over the next 20 years, and as a result has been able to increase its dividend every year since the purchase. While the company has no control over its stock price, which is one of the key factors determining its performance, it does have control over the actual amount of the quarterly dividend payout. The dividend yield has fluctuated over the past 20 years, while its payout has steadily increased over the same period. In fact, the dividend payout has steadily increased over the past 28 years!

The yield on the cost of Johnson & Johnson (JNJ) has been steadily increasing with the annual increase in dividends and reached 23,50% in 2010. This source of income was three times higher than what investors could have obtained with Treasury bonds in 1990. The growth of this source of income has also outpaced inflation during the period studied. Last but not least an investment of 100 $ in Johnson & Johnson (JNJ) at the end of 1990, with dividends reinvested, would be worth 9,646 $ in August 2010.

Most of the dividend aristocrats have managed to produce very good total returns over the last twenty years, coupled with solid returns on purchase costs. Investors who are able to understand the power of dividend growth stocks have been able to generate an income stream that has outpaced inflation.

In conclusion, a company that yields 2-3% today and increases its dividends over many years rewards its shareholders with higher yields on acquisition cost than so-called high-yield stocks. Investors who buy stocks in companies that regularly increase their dividends enjoy higher income over time and equally solid capital gains.