I used to think that a 6%-8% yield was a reasonable range for a diversified income portfolio. I've modified my perception, because I have woefully underestimated the potential yield a diversified income portfolio can deliver.
I say that because the more I analyzed dividend-paying stocks (and dividend-growth stocks in particular), the more I realized I was failing to fully account for income potential over time.
A couple of weeks ago, I wrote an article on the wonders of dividend-growth investing. I focused on two dividend-growth stocks in the High Yield Wealth portfolio – McDonald's Corp. (NYSE:MCD) and McCormick & Co. (NYSE:MKC).
McDonald's yields 3.4% based on a $90-per-share market price and a $3.08 annual dividend. McDonald's has been in the High Yield Wealth portfolio for almost two years. Based on a $75.17 cost-basis price, McDonald's yields 4.1%.
Back in January 2011, McDonald's yielded 3.3% based on the $2.44 annual dividend it paid at the time. The yield has risen because McDonald's has raised its dividend. What's more, I expect McDonald's will continue to raise its dividend. This means the yield will continue to grow on the cost basis.
McDonald's incremental yield increase might seem insignificant, but it can be a remarkably powerful wealth-producing tool.
If you had bought McDonald's five years ago, you'd own an investment that yields 5% today. If you had bought McDonald's 10 years ago, your investment would yield 10%. If you'd bought 30 years ago, your investment would yield more than 100% (and has held steady above 100% for the past couple of years).
So if you had bought McDonald's in the early 1980s, you'd own an investment that would return your purchase price each year in dividends. (And as time marches on and the dividend is increased, McDonald's will deliver more than the purchase price each year in dividends.)
Though not quite to the same degree as McDonald's, an investment in McCormick has a similar wealth-building effect. If you had bought McCormick 15 years ago, you'd own an investment that yields roughly 12%.
The longer the time frame, the greater the compounding effect.
Now I like gold, because it's a store of value. It’s also a good diversifying asset, though it’s not a cash-generating asset.
In 1971, the year the United States government dropped all pretense of tethering the dollar to a gold standard, the average price of gold was $40 an ounce. The average split-adjusted price of a share of ExxonMobil was about $2.30.
Today, gold trades near $1,700 an ounce; a share of ExxonMobil trades near $90. Gold has appreciated at an average annual rate of roughly 9.6% over the past 41 years. ExxonMobil's share price has appreciated at an average annual rate of 9.4% over the same period.
But ExxonMobil would have been by far the more remunerative investment. ExxonMobil is a dividend grower, and has paid and increased its dividend for decades.
Today, ExxonMobil pays $2.28 per share in annual dividends. This means ExxonMobil is paying the initial purchase price each year in dividends – that's an automatic 100% annual return on investment today. And keep in mind, I'm not factoring in all the dividends accumulated (and possibly reinvested) over the years.
I'm convinced dividends will continue to be the driving variable in stock valuation for years to come. What's more, it will be the most reliable variable. When companies consistently increase earnings and dividend payments, share price is sure to follow.
The High Yield Wealth portfolio is composed of dividend-growth stocks, higher-yield master limited partnerships and a smattering of fixed-income investments. The portfolio is well-diversified over industry and geography. It currently yields above 7%.
As time passes, the yield on the portfolio has increased (and not just because of the inclusion of higher-yield securities). Many of the investments in the portfolio have hiked their dividend payouts over the past year, thus raising the cost-basis yield.
When I first considered a high-yield investing strategy, my goal was to devise a portfolio that yielded between 6% and 8% annually. To be sure, that's a worthy starting point. But years from now, I should expect to own a portfolio that yields 25%, 50% and even 100% on the cost basis of many of the investments in that portfolio.