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Compounding and Dividend Growth Investing

Compounding and Dividend Growth Investing – Dividend Power Week In Review

Compounding and Dividend Growth Investing

I have often talked about leveraging the power of compounding in dividend growth investing. I just gave a presentation on dividend growth investing on the Money Show this past week where I talked about the concept. But what exactly does that mean in context of dividend growth investing? Does compounding really work for dividend growth investing? I would argue that it does. I have talked about the several advantages and the risks of dividend growth investing. Leveraging the power of compounding over time is one of them. The main challenge for some investors is exactly that though, time and staying invested. You need the patience and discipline to take advantage of the power of compounding.

Compounding and Dividend Growth Investing
Compounding and Dividend Growth Investing

What Exactly is Compounding and Dividend Growth Investing?

The concept of compounding is fairly simple. The easiest example is a simple savings account. You deposit money in your savings account at a bank that earns interest although today interest rates are very low around the world. The interest that you earn is deposited in your account monthly assuming monthly compounding. The following month you earn interest on your initial principal and also the interest from last month. This process keeps on going. But how does this work for dividend growth investing?

Compounding in dividend growth investing is the process of where you buy a dividend growth stock and then reinvest the dividends. The simple way to accomplish this is to allow the dividends to reinvest automatically each quarter and buy more shares of the same stock. An alternate way to do this is to receive the dividend payment in cash and then manually repurchase shares in the most undervalued or stock that you own the least of. The second way is obviously more effort and I personally prefer the first way. The only drawback that I have found is that the dividend of some stocks cannot be automatically reinvested and must be done so manually since they lack a DRIP plan.

Compounding and Dividend Growth Investing – Simple Example

I am going to discuss a simple example of a hypothetical stock that I will call Company Z.

If Company Z is trading at $40 per share in 2021 and pays $1.20 per share in regular cash dividends annually this gives the stock a 3% dividend yield. This is decent and more than the roughly 1.5% offered by the S&P 500. For simplicity let’s say we buy 50 shares of Company Z for $2,000 as our initial investment. In the first quarter, we would receive $15 in dividends ($1.20/4 * 50 shares). It does not sound like much. But if we reinvest it then we can buy 0.375 shares of Company Z assuming the stock price is the same. Note that this is a simplification for purpose of this example. In the second quarter, we would receive $15.113 in dividends. This too is reinvested, and we buy another 0.378 shares. We now own 50.753 shares. That generates a dividend of $15.226 in the third quarter. The process continues each quarter. By leveraging the power of compounding, we grow our initial principle by reinvesting the dividends that in turn results in a greater stream of dividends.

In reality, the above example is oversimplified. We did not account for the dividend growth each year. In addition, we expect the stock price to appreciate on average over time. How much does our initial $2,000 grow to after 10 years? We make two more simplifications, the dividend growth rate is constant at 5% per year and the stock price appreciates at a constant 5% per year. 

We then use one of the many popular dividend growth and reinvestment calculators online. Our initial $2,000 has grown to $4,378.20. We now have 67.2 shares of Company Z. The stock has paid us $919.18 in dividends, which was reinvested. Our annualized total return is 8.15%. On the other hand, if we do not reinvest the dividends the final value is only $4,050.20. We have only been paid $792.41 in dividends. Our annualized total return is 7.31%. You can clearly observe the effect of leveraging the power of compounding in dividend growth investing.

Compounding and Dividend Growth Investing – Real World Example

In reality the dividend growth rate and prices appreciation are not constant and growth rates fluctuate with time. Even if you know the trailing averages for the past decade or even 5-years it does not predict this, or future growth rates or returns. What about a real-world example of compounding and dividend growth investing? So, in the screenshot below, we use Proctor & Gamble (PG) as an example. The company is a well-known dividend growth stock having raised the dividend annually for 65 years in a row. Proctor & Gamble is a Dividend King.

If we invest $10,000 about 10-years ago at $64.54 per share we started with 154.94 shares. In year 1 we receive about $81 – $83 per quarter in dividends and $329.38 annually. By year 10 the stock price has doubled to $128.22. We are receiving $163 – $166 per quarter in dividends and $657.07 annually.

If we reinvest the dividends, we have 210.90 shares, and the dollar value is $27,035.35. Our total annualized return is 10.46%. On the other hand, if we do not reinvest the dividends, the dollar value is only $23,973.72 and our total annualized return is 9.14%.

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Source: DRIP Returns Calculator

Final Thoughts on Compounding and Dividend Growth Investing

The above discussion and examples clearly show that dividends matter and the effects of compounding and dividend growth investing especially when you are trying to build wealth and generate my favorite kind of money which is passive income. The main factors here are starting yield, dividend growth rate, and time. As the years pass, an initially small annual dividend will grow into a much larger annual dividend. If you extrapolate out for a few more years, the annual dividend will have crossed the $1,000 mark and it is heading higher. Now imagine if you build a basket of stocks…you get the idea. Yes, getting to the first $100,00 is the hardest but eventually it will start snowballing and your total portfolio value will grow as will your passive income stream. If you still don’t think it is possible then read some of my millionaire interviews or about the secret dividend millionaires.

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Chart or Table of the Week

This week I highlight AbbVie (ABBV), the pharma company that was spun out of the Abbot Laboratories (ABBT) in 2013. AbbVie’s top product is Humira, which annually generates close to $20B in revenue and half of the company’s profits. Humira is the world’s best-selling drug but patent expirations are looming. AbbVie completed its acquisition of Allergan in 2020 adding to its pipeline. The stock is worth looking since it is yielding almost 5% and is a dividend growth stock. This combination can lead to decent compounding and dividend growth investing over time.

The screenshot below is from Stock Rover* and shows the trailing yield and dividend growth for AbbVie in the past decade. Clearly, the yield is at the higher end of its range although it was over 6% at times since 2019. The annual forward dividend of $5.20 per share gives a payout ratio of 42%. Consensus adjusted earnings for 2021 is $12.38 giving a forward P/E ratio of 8.6X. The low P/E ratio suggests that there is a margin of safety for this stock. AbbVie is a Dividend Aristocrat.

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Source: Stock Rover*

Dividend Increases and Reinstatements

Now for a list of stocks that can help you with compounding and dividend growth investing.

Jack Henry & Associates (JKY) hiked the dividend 7% to $0.46 per share quarterly. The forward yield is 1.2%. This is the 31st consecutive annual increase. Jack Henry is a Dividend Champion.

Public Service Enterprise Group (PEG) raised the dividend 4.1% to $0.51 per share quarterly. The forward yield is 3.6%. This is the 18th straight annual increase. PSEG is a Dividend Contender.

Analog Devices (ADI) increased the dividend 11.3% to $0.69 per share quarterly. The forward yield is 1.7%. This is the 18th yearly increase in a row. Analog Devices is a Dividend Contender.

Genuine Parts Company (GPC) hiked the dividend 3.2% to $0.815 per share quarterly. The forward yield is 3.2%. This is the 65th annual increase in a row. Genuine Parts is a Dividend King and one of only nine companies to have raised the dividend for 60+ years.

Excel Energy (XEL) raised the dividend 6.4% to $0.4575 per share quarterly. The forward yield is 3.0%. This is the 17th straight annual increase. Excel Energy is a Dividend Contender.

Foot Locker (FL) increased the dividend 33.3% to $0.20 per share quarterly. The forward yield is 1.6%. Foot Locker had previously cut the dividend at the height of the pandemic.

EnPro (NPO) hiked the dividend 3.8% to $0.27 per share quarterly. The forward yield is 1.5%. This is the 5thconsecutive annual increase. EnPro is a Dividend Challenger.

Sherwin-Williams raised the dividend 23.1% to $1.65 per share quarterly. The forward yield is 0.9%. This is the 42ndyearly increase in a row. Sherwin-Williams is a Dividend Champion and Dividend Aristocrat.

Walmart (WMT) increased the dividend 1.9% to $0.55 per share quarterly. The forward yield is 1.5%. This is the 48thstraight annual increase. Walmart is a Dividend Champion and Dividend Aristocrat.

Coca-Cola (KO) hiked the dividend 2.4% to $0.42 per share quarterly. The forward yield is 3.3%. This is the 59thconsecutive annual increase. Coca-Cola is a Dividend Champion and Dividend Aristocrat.

Essex Property Trust (ESS) raised the dividend 0.6% to $2.09 per share quarterly. The forward yield is 3.2%. This is the 27th yearly increase in a row. Essex is a Dividend Champion and Dividend Aristocrat.

Omnicom Group (OMC) increased the dividend 7.7% to $0.70 per share quarterly. The forward yield is 4.3%. This is the 5th consecutive annual increase. Omnicom is a Dividend Challenger.

Humana (HUM) hiked the dividend 12% to $0.70 per share quarterly. The forward yield is 0.8%. This is the 9th straight yearly increase. Human is a Dividend Challenger.

Reliance Steel & Aluminum raised the dividend 10% to $0.6875 per share quarterly. The forward yield is 2.2%. This the 11th straight annual increase. Reliance is a Dividend Contender.

Telephone and Data Systems (TDS) increased the dividend 2.9% to $0.175 per share quarterly. The forward yield is 3.5%. This is the 46th yearly increase in a row. TDS is a a Dividend Champion.

Arbor Realty Trust (ABR) hiked the dividend 3.1% to $0.33 per share quarterly. The forward yield is 8.6%. This is the 8th straight yearly increase. Arbor is a Dividend Challenger.

Dividend Cuts and Suspensions List

I updated my dividend cuts and suspensions list three weeks ago. The number of companies on the list has risen to 511. We are well over 10% of companies that pay dividends having cut or suspended them since the start of the COVID-19 pandemic.

No new companies were added to the list in the past week.

No missed companies were added to the list.

Market Indices

Dow Jones Industrial Averages (DJIA): 31,495 (+0.12%)

NASDAQ: 13,874 (-1.57%)

S&P 500: 3,907 (-0.71%)

Market Valuation – Compounding and Dividend Growth Investing

The S&P 500 is trading at a price-to-earnings ratio of 39.78X and the Schiller P/E Ratio is at about 35.6X. These two metrics are down this past week. Note that the long-term means of these two ratios are 15.9X and 16.8X, respectively. 

I continue to believe that the market is overvalued at this point. I personally view anything over 30X as overvalued based on historical data. Note that we are at 40X and approaching valuation levels near the top of the dot-com era. That said, interest rates are at or near record lows, which has been a tailwind for rising stock prices.

S&P 500 PE Ratio

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Source: multpl.com

Shiller PE Ratio

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Source: multpl.com

Stock Market Volatility – CBOE VIX

The CBOE VIX measuring volatility rose about two full percentage points this past week to 22.05. Three weeks ago, the VIX was at 33.09. The long-term average is approximately 19 to 20. So, at this point we are just above the long-term average.

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Source: Google

Fear & Greed Index

I also track the Fear & Greed Index. The index is now in Greed at a value of about 59. This is after plunging into Fear three weeks ago.

There are seven indicators in the index. They are Put and Call Options, Junk Bond Demand, Market Momentum, Market Volatility, Stock Price Strength, Stock Price Breadth, and Safe Haven Demand.

Junk Bond Demand is indicating Extreme Greed. Investors are accepting 2.11% yield over investment grade corporate bonds. The spread is down from recent levels indicating that investors are taking on more risk.

Stock Price Breadth is indicating Extreme Greed as advancing volume is 8.62% more than declining volume on the NYSE. This is upper end of its range over the past two years.

Market Momentum is indicating Greed. The S&P 500 is 8.77% over its 125-day average. This is at the upper end of its range over the past two years.

Stock Price Strength is signaling Greed. The number of stocks hitting 52-week highs compared to those hitting 52-week lows is at the upper end of its range.

Market Volatility is set at Neutral. The CBOE VIX reading of 22.05 is a neutral reading.

Safe Haven Demand is in Fear. Stocks have outperformed bonds by 3.03% over the past 20 trading days. This is near the weakest performance over the past 2-years.

Put and Call Options are signaling Extreme Fear. In the last five trading days, put option volume has lagged call option volume by 51.87%. This is amongst the highest level of put buying in the past two years.

Source: CNN Business

Economic News

The number of weekly new unemployment claims were up with last week at 861,000. This is up 13,000 from last week’s revised numbers. The 4-week moving average has been consistently above 800,000 for many weeks. For some perspective, one-year ago weekly unemployment claims were only about 215,000. Currently we are 3X – 4X the normal level. The seasonally adjusted insured unemployment rate was 3.2%.

U.S. Commerce Department reported retail sales climbed a seasonally adjusted 5.3% in January following 3 months of declines. December’s drop in retail sales was actually larger than it first reported, revising down 1% instead of 0.7%. January’s increase in retail sales was across the board: Motor vehicle and parts reported a 3.1% increase, furniture stores surged 12.0%, electronics and appliance soared 14.7%, clothing stores rose 5.0%, and sporting goods were up 8%. Sales were strong in department stores with a 23.5% increase, while online sales climbed 11%.

U.S. Bureau of Labor Statistics reported the Producer Price Index for final demand increased a seasonally adjusted 1.3% in January. This is the largest gain since December 2009 and follows a 0.3% increase in December. The core PPI (excluding the food, energy, and trade services components), was up 1.2% in January. For the 12 months through January, the core PPI increased 2.0%. Prices for final demand goods increased 1.4%.in January, the largest since May 2020.  Some 60% of the increase is attributed to a 5.1% rise in final demand energy prices.

The National Association of Realtors reported that previously occupied U.S. homes increased by 0.6% in January 2021 to a seasonally adjusted rate of 6.69 million annualized units. Sales increased by 23.7% as compared to last year, the highest sales rate since October. Housing prices also went up in January at an average price of $303,900, an increase of 14.1% from a year earlier. There was also an all-time low inventory of 1.04 million homes for sale, a 25.7% decline over a year ago. Seventy-one percent of the homes sold in January 2021 were on the market for less than a month.

Thanks for reading Compounding and Dividend Growth Investing – Dividend Power Week In Review!


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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.

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