Investors that are looking for long-term income have many possible choices. Investors that are close to retirement, or already retired, are likely to choose stable stocks with predictable earnings, and high dividend yields. But for those that have a longer time horizon, there’s another way to go about it that can generate higher income over time.

In this article, we’ll take a look at investing for dividend growth, rather than investing for current yield. Dividend growth investing could produce not just higher levels of income later on, but stronger capital gains as well. This strategy is therefore well suited for younger investors in particular, as they have the time to let dividend growth compounding work its magic.

Many examples of great dividend growth stocks can be found among the Dividend Aristocrats, and we’ll examine the characteristics of some of the best examples below.

What Is Dividend Growth Investing?

Dividend growth investing is selecting great stocks that have ability to increase their payouts at high rates over the long-term. Stocks with high current yields generally don’t also produce high rates of dividend growth, as the earnings characteristics for high-yield stocks versus high dividend growth stocks are fundamentally different.

Dividend growth stocks generally have high rates of earnings growth, which increases the amount of cash available to management to return to shareholders over time. In other words, stocks with lower growth rates, such as utilities, tend not to be great dividend growth stocks because their earnings increase at a slower rate over time.

But that’s not the only criteria; the management team has to be willing to return ever-increasing amounts of cash to shareholders as well. It’s that combination of willingness and ability to return cash that makes dividend growth stocks special.

How Does Dividend Growth Investing Work?

Dividend growth can provide investors with a virtuous combination of capital gains and dividend growth over time. In general, since dividend growth stocks tend to be ones that have reliable long-term growth in earnings, their share prices tend to rise over time as well. That means that when an investor purchases the stock and holds it for long periods, the value per-share rises. That is another distinction from high-yield investing; stocks with lower dividend growth rates – in general – see their share price rise more slowly than those with higher rates of earnings growth, all else equal.

In addition, stocks that reliably boost their dividends at high rates over time receive higher valuations from the market because investors know those companies are likely to return more and more cash over time, increasing the net present value of the dividend stream long-term.

These factors combine to make dividend growth stocks highly valuable as a mix between growth and yield investing, and why they work so well for younger investors.

In addition, companies with great dividend growth are very unlikely to need to cut or freeze their payouts during recessions. Because the best dividend growth stocks have strong and growing earnings streams, the odds of earnings declining enough during a tough economic period to need a cut are much lower than a company with low earnings growth, as well as a high payout ratio.

Stocks that cut or freeze their dividends generally see poor share price performance as the value of their dividend streams declines, so finding the best dividend growth stocks can help investors avoid this, further adding to long-term outperformance.

Dividend growth stocks also offer a distinct advantage in terms of yield on cost. That is simply the yield an investor receives on the purchase price of their shares. For dividend growth stocks, yield on cost can soar over time as the dividend grows rapidly.

As an example, just ten years ago, PPG Industries (PPG) was trading for about $50 per share. The stock now pays an annualized dividend of $2.36 per share, so investors that bought ten years ago are receiving a yield on their cost of nearly 5%. By contrast, investors that buy today receive a yield of just 1.8%. The difference is in letting dividend compounding work over time, and that’s why finding great dividend stocks and letting them grow can be so lucrative.

3 Dividend Growth Stocks

PPG Industries (PPG) is an example of a great dividend growth stock. The company has boosted its payout for 50 consecutive years, making it a member of the extremely exclusive Dividend Kings. But in addition to that, it has boosted its dividend by an average of more than 7% in the past decade, providing investors with rapidly rising income over time. We expect PPG to grow earnings at 8% annually in the years to come, meaning it should have plenty of cash available to continue to boost its payout for many years.

Another example is Parker-Hannifin (PH), a stock that has grown its dividend for a staggering 65 consecutive years. Like PPG, it is a Dividend King, but unlike some stocks with long dividend increase streaks, it is an outstanding dividend growth stock as well. Parker-Hannifin’s 10-year average dividend increase stands at more than 10%, putting it in truly elite company in terms of combining dividend longevity and growth. We see 9% earnings growth in the years to come, giving the management team plenty of cash to return to shareholders.

Our final example of a terrific dividend growth stock is Stryker (SYK), and while it’s not a Dividend King, it sports a dividend increase streak of nearly three decades. The company has also proven to be exemplary for dividend growth, with its ten-year average increase clocking in at 12%. We expect Stryker to grow earnings at 12% annually for the foreseeable future as well, meaning shareholders should see a long runway for further dividend increases ahead.

Final Thoughts

For those looking for a lucrative mix of rising income and capital appreciation, dividend growth investing is difficult to beat. Dividend growth investing offers the chance to own companies that have long-term competitive advantages that afford them the ability to return growing streams of income over time to shareholders, boosting yield on cost.

When looking for great dividend growth stocks, the combination of high earnings growth and a management team that has a track record of returning cash to shareholders can produce strong results, such as with PPG, Parker-Hannifin, and Stryker.
_______________

Bob Ciura has worked at Sure Dividend since October 2016. He oversees all content for Sure Dividend and its partner sites. Bob received a Bachelor’s degree in Finance from DePaul University, and an MBA with a concentration in Investments from the University of Notre Dame.