If you want to start a brawl with usually easy-going dividend investors, mention a stock with a low yield.
Something yielding around 2% will probably pull them off their bar stools, and at about 1% the fists start to fly.
Fun to watch, even better than hockey.
Of course, it’s understandable that income investors who want to maximize their immediate paycheck will bypass low yields. And some dividend investors successfully specialize in high-yield trades.
But investors with long-haul time horizons might keep in mind that low-yielding dividend-growth stocks include some of the best capital appreciation investments anywhere. These stocks can build shareholder wealth far beyond the reach of any dividend yield.
Three I’m quite familiar with are industrial distributor Fastenal (FAST), data processor FactSet Research Systems (FDS) and healthcare products supplier Owens & Minor (OMI). More on each of them in a minute.
But first, it’s important to say that I’m profiling these stocks to illustrate how low-yield dividend growers can deliver sky-high returns, rather than to recommend any of them as appropriate for every investor.
Let’s start with what these three stocks have in common, besides roughly quadrupling over the past ten years.
All are smallcap or midcap companies with growing revenues and profits and good cash flows. They maintain clean balance sheets and ring up good returns on equity. All have increased dividends for at least ten consecutive years. And they occasionally show multiples that make value investors run away screaming.
Midcap FAST distributes specialized hardware for maintenance, repair, and construction operations. FAST recently notched ten years of dividend increases to earn Dividend Achiever status.
Its yield? A measly 1.4%, even after hiking its dividend by double digits each of the past five years. Over those five years FAST’s year-end yield ranged from a stinking .8% to a lousy 1.7%.
But the stock clocked average annual total returns around 16% over both the past five and ten years. Since it began raising dividends a decade ago, FAST quadrupled while the S&P 500 got flattened.
FAST is a healthy business, with return-on-equity of 16% and no long-term debt. Though cyclically depressed sales and earnings produce high valuations right now, FAST generates good cash flow and its earnings should benefit as manufacturing and construction improve.
Despite a couple of rough years for its customers in those sectors, over both the past five and ten years FAST increased revenues on average about 7% annually and earnings about 11%.
Financial software and data provider FDS marked ten years of dividend increases in 2009 and will likely announce another double-digit boost within the next week or two.
Midcap FDS carries no debt. Return on equity is 31%. Revenue and earnings growth have popped about 20% annually for the past five and ten years. The P/E sits in the mid-20s, not an unusual spot for it.
The stock’s current 1% yield would make some investors cry, but its 22% average annual returns for the past five years might cheer them up again.
Echoing FAST, since it began raising dividends a decade ago FDS has nearly quadrupled. Also a die-hard low-yielder, it’s year-end yield ranged from .4% to 1.5% over the past five years.
Owens & Minor
OMI, a smallcap medical and surgical supplies distributor, has hiked dividends for 13 straight years. Increases averaged about 15% annually over the past five years.
Revenues and earnings at OMI racked double-digit gains for the past five and ten years. Return on equity is 14% and debt-to-equity a manageable 30%. With a P/E still in the teens, the stock’s valuation has begun rising again.
Boasting a 2.2% yield, which is higher than its usual level, OMI plays the big spender in this group. But like the others, the real money came from stock price gains, with 13% average annual total returns over the past five years, and nearly 17% over the past ten. Another quadruple.
So it’s not too tough to see the thread here. Healthy, fast-growing small and mid-sized businesses giving shareholders hefty dividend bumps but not high yields.
Some investors might counter that they can get fine returns from big dividend blue chips with better yields.
And they’re right.
Over the past very tough ten years stalwarts like Emerson Electric (EMR), Johnson & Johnson (JNJ), McDonald's (MCD), PepsiCo (PEP) and others produced average total returns above mid-single digits annually. And Procter & Gamble (PG) and United Technologies (UTX), for example, hit double-digits.
Nothing wrong with that, though diversifying with a smattering of smaller, faster growers wouldn’t be wrong either.
I will take exception, however, with those who object to gunning for capital appreciation via dividend-growth stocks like FAST, FDS and OMI.
The argument there seems to be that non-dividend-payers are generally a better bet.
But lots of good research says otherwise. Dividend raisers as a group wallop non-payers when it comes to stock price appreciation, raising the stock-picker’s odds of success. Giving shareholders strong, regular dividend increases is the hallmark of healthy businesses with robust cash flow and good growth prospects.
You can look elsewhere for stellar growth stocks. You just don’t have to.
For more about dividend growth, including research references and links, check out my Seeking Alpha articles, “Six Big Benefits of Stocks That Raise Dividends,” published April 15 and “Why Stocks That Raise Dividends Trounce the Market,” March 12.
References and Links
- Morningstar, “Fastenal Performance and Yield History,” May 2010.
- Morningstar, “FactSet Research Systems Performance and Yield History,” May 2010.
- Morningstar, “Owens & Minor Performance and Yield History,” May 2010.