I love dividend paying stocks. They pay you to wait on their share prices to grow with dividends. A company’s dividend growth rate is a good proxy for how much their share price should also grow.
A company’s share price is the present value of all its future cash flows (dividends) according to classic finance theory. So, a simple way to look at it is that a company who is increasing its dividends by 3% to 5% each year should see its share price of its common stock growing at approximately the same rate.
An Example of the Dividend Growth Rate in Action
To give you an example, let’s look at one of my favorite companies, Coca-Cola (Stock Symbol: KO). In 2002, the Coca-Cola company issued a quarterly dividend of 10 cents or 40 cents per year (adjusted for the 2 for 1 stock split that took place in 2012). The share price of Coke at that time was right at about $50 (or $25 factoring the split). Over the past eleven years, Coca-Cola’s dividend has increased to 28 cents per quarter or $1.12 per year. That is a 9.8% annual increase in their dividend.
Currently, Coca-Cola’s stock price has risen to $39.23 this year. That actually equates to only a 4.2% annual rise in the price of their stock (stock split adjusted). Of course, that rise hasn’t been on a straight line but ebbs and flows with the macro economy as well. So, using this dividend growth rate and the share price, it is not out of line to say that Coca-Cola may be undervalued at these levels using this metric alone. Of course, it’s not always wise to put all of your investing eggs into the one basket of a single metric. There’s more to a stock price than that.
A recent reader questioned the validity of a dividend aristocrat as a growth stock. His argument was whether or not you could find a growth stock among those dividend aristocrats. He asked, why invest in a dividend aristocrat because after 25 years of consistently rising dividends, how much growth could there be left in the shares?
The question, like most, begs for a little further examination. It made me dig into some questions? When does a growth stock become a value play? Can a dividend aristocrat be a growth stock? Or, is it a value stock by its very nature? And, what role does the dividend payout ratio play in our determinations?
Understanding Growth Stocks vs Value Stocks
Investopedia defines a growth stock as a stock whose share price grows at a faster rate than the overall stock market. Last year, of course, the S&P 500 Index saw a 13% gain, and it is set to make a comparable run here in 20113 as well.
Conversely, a value stock is the ying to growth stocks’ yang. Value stocks are often undervalued when compared to the company’s financial metrics. Investors often find that value stocks have a higher dividend yield, lower price to book ratio, and often a lower price to earnings (PE) ratio than growth stocks traditionally.
Can A Dividend Aristocrat Be A Growth Stock Too?
Yes, a dividend aristocrat can be a growth stock also, but it may be unlikely. They are more likely to be a value stock and a blue chip company. Out of the 59 dividend aristocrats in the S&P 500 index, many have seen year over year share price growth of over 13% in recent years. While we may not consider strong dividend payers as high growth companies, the possibility is still out there for those companies to provide both income and capital appreciation to shareholders.
Dividends are like the third rail for public companies. Most board members and executives would much rather do something drastic like borrow money instead of reducing their dividend payments to shareholders. So, there is something to be said for dividend aristocrats who continue to raise their dividends year in and year out improving their shareholder’s personal finances.
What Are Dividend Aristocrats?
A dividend aristocrat is a company that has consecutively raised its dividend every year for at least 25 years. The 25 year mark is of increasing dividends every year at least once if not more times within a year is hard to do. Twenty-five years shows consistent growth through all types of bull and bear markets, dips, downturns, and even recessions. Dividend aristocrats have shown investors that they are consistent and growing winners in the stock market that can be trusted.
Dividend aristocrats are often blue chip stocks. These stocks have paid a consistent dividend with solid returns for many years. Many of these stocks have increased their dividends substantially over time, and some of them have even increased their dividends quarterly.
Dividend aristocrats not only pay their dividend, but these are also high growth stocks that have consistently put up good numbers. Imagine realizing a consistent return from growth, even a split, and then turning around to receive a dividend as well.