The notion of a dividend growth strategy isn't something which should be considered the domain of only older investors. Younger investors can benefit from building up a steady, growing income stream over time which can allow for a nice income supplement, or even assistance with a significantly early retirement, if given enough time.
Starting with stable, well established, consistent dividend growth payers should be part of the core of any investor's portfolio. Having these dividend payers in one's portfolio will help provide some income stability to the portfolio, as well as stock price stability. These companies have developed strong competitive advantages and have generally been able to construct wide moats for themselves over many years. With very strong value propositions, they enjoy superior returns on equity and have been able to develop a long streak of paying and increasing their dividends. Most importantly, these larger dividend payers tend to pay moderate yields of around 3-4% and provide consistent increases in their dividends of at least the rate of inflation.
A large, well known brand and operational efficiency give McDonald's a sustainable competitive advantage and economic moat. With a current yield of 3%, McDonald's has increased operating cash flow at greater than 10% per annum in the 2006-2011 period, with dividend growth of greater than 20% per annum over this period. McDonald's has raised its dividend each and every year since first paying a dividend in 1976.
Similarly, intellectual property and distribution scale give the Coca-Cola Company a large economic moat. With a current yield of 2.7%, the Coca-Cola Company has increased operating cash flow at almost 10% per annum in the 2006-2011 period, with dividend growth of close to 9% per annum over this period. The Coca-Cola Company has been paying a dividend since 1920 and has increased its dividend in each of the last 50 years.
The longevity of earnings records and dividend payment that one finds with McDonald's and the Coca-Cola company are rare and make these companies a core holding for any investor, including a younger investor.
One of the primary advantages that younger investors have over older investors is that they can afford to be more patient and less aggressive when it comes to requiring a higher initial yield. Given that retirement for a younger investor is likely to be many years away, adding some stocks that have lower present yield, but stronger dividend growth potential can be of significant benefit. A lower current yield allows a company to reinvest in the business and compound earnings growth well into the future. This allows an investor to harvest an initially smaller but rapidly growing income stream over many years.
Dividend growth stocks that have a lower initial yield yet faster growth may take a longer period of time to provide the same dividend income of a higher yielding stock, but if you have a long holding period (which hopefully you should as a younger investor), you can really start to get a strong dividend payoff midway into your holding period.
Visa is not traditionally thought of as a dividend growth stock due to its relatively small yield of 0.8%, but it has provided dividend growth of 27% per annum over the last 3 years. For those with a longer-term time horizon, Visa offers significant growth potential from its exposure to emerging markets as well as trends in Mobile Point of Sale Acceptance. Both should significantly accelerate revenues and drive future dividend growth.
Finally, having an eye to some emerging dividend payers in international markets has the potential to reward younger investors quite significantly over time, not only through exposure to economies with strong economic growth, but also through appreciation of international currencies against the US dollar. Emerging international economies should continue to grow and attract foreign investment, which should lead to the appreciation of their currencies relative to the U.S. dollar over time.
India's ICICI Bank Ltd. (IBN) offers a dividend yield of 1.2% and has been able to grow its dividend some 13% per annum over the last three years, while still having a modest payout ratio of just 22%. Investors in ICICI bank should likely experience growth not only from India's middle class consuming more wealth management services, but also from the likely appreciation of the Indian Rupee against the US Dollar over time.
Younger investors can benefit from holding the same large cap stocks that investors approaching retirement also hold. Stocks including McDonald's and The Coca-Cola Company are the bedrock of any dividend portfolio, with superior business models and long records of earnings and dividend increases. In addition, younger investors can also benefit from selectively holding strong companies with a smaller dividend yield but rapid dividend growth as well as companies that provide international exposure. This will help to further accelerate dividend income over the long term.