The $27,000 Millionaire: Dividend Growth Unleashed

| About: Johnson & (JNJ)

Johnson & Johnson (NYSE: JNJ), a long time member of the Dow Jones Industrial Average and consistent dividend stock, has been a phenomenal investment over the last 40 years. Its track record can be used to emphasize a key point about retirement investing - time and consistency are the best friends that an investor can have.

JNJ is a leading global consumer health care company with more than 250 operating companies throughout the world. JNJ has three operating segments: Consumer, Pharmaceutical, and Medical Devices and Diagnostics. Their Consumer Segment manufactures and markets products under many brand names including Listerine, Neutrogena, Tylenol, and Sudafed. The Pharmaceutical Segment provides products, including Remicade for certain inflammatory diseases and Intelence for HIV/AIDS patients. The Medical Devices and Diagnostics Segment makes JNJ the world's largest and most diverse company in this space.

JNJ provided a road to wealth
I've computed the impact of making periodic investments to JNJ as well as reinvesting its dividends. Starting with an initial investment of just 10 shares, reinvesting dividends and making additional quarterly investments of $150 would result in a position worth just over $1 million paying almost $35,000 of dividends per year (assuming the investor chooses to turn off dividend reinvestment). These annual dividends represent a sum greater than the initial stock purchase and subsequent recurring purchases. The following graph shows the breakdown:

Price histories and dividend amounts from Yahoo!Finance.

One can see that the bulk of the position came from stock appreciation. The following table shows a breakdown of the current position divided among dividends, stock appreciation, and investments. The investment bucket includes the initial and recurring purchases.

Allocation of Current Position
Category Contribution ($ 000) Percent of Total
Stock Purchases 27 3%
Dividends Paid 272 26%
Stock Appreciation 741 71%
Total 1,040 100%
Click to enlarge
Source: Author Calculations

This table excludes the dividend income taxes, which are not insignificant and effectively represent incremental "investment". Assuming a long run effective tax rate of 25% implies gross tax payments of almost $70,000 over the 40 years. Note that today these dividends would be taxed at a 15% qualified dividend rate, reducing the current tax burden. However, this rate would be different in earlier years and the impact will vary by individual situation over that time. In most cases, the total cash outlays for the investor should be less than $100k over the 40+ year time period.

The power of dividend growth
There is one quick calculation that highlights the benefits of growing dividends. The initial purchase of 10 shares for $1,755 is now 1,440 shares worth $94,522. This position should pay $3,413 in dividends next year or 194% of the initial purchase amount - a truly impressive yield on cost. While I don't think yield on cost is a useful measure for analyzing stocks, it does clearly demonstrate the impact of dividend growth.

Slowing growth ahead...
Over the past 40 years, JNJ dividend growth has been at an annual rate of about 15%, which is a staggering pace to maintain for that period of time. JNJ currently offers a forward dividend yield of 3.6% based on its recent closing price of $65.64 and my estimated forward dividend of $2.37. The next quarterly dividend should be $0.57 per share and then I would expect JNJ to announce an increase to at least $0.60. This yield compares favorably to historical dividend yields which is reflective of the more mature nature of JNJ. Its growth has also declined from a long term average around 15% to just single digits. The increase from $0.57 to $0.60 is just 5.3%. This would represent the lowest increase in at least 15 years; however, the last increase was just 5.6% and other recent increases have been around 10%.

Finding the next JNJ
Unfortunately, this is hindsight analysis to illustrate the point of consistent, patient investing and not a forward looking perspective. JNJ has provided very atypical performance. In the same time frame, countless companies that looked promising have gone bankrupt. I would not expect JNJ to provide the same track record over the next 40 years; however, it should continue to be a strong performer given its consumer products and ability to expand and grow in emerging markets.

I would think that there are several companies capable of delivering these JNJ performance over the next 40 years. The obvious challenge is figuring out which ones. I would look more towards the technology and services sector. The company would need to still be relatively small to have an ability to grow sufficiently. Alternatively, one could go broad and consider iShares MSCI Emerging Index Fund (NYSEARCA:EEM) which is yielding a little over 2%. The benefits of this approach would be that over 40 years, I would expect emerging markets to provide substantial growth. The one challenge is that at 2% the dividend yield is not very compelling. However, over the last 40 years, one should note that JNJ often provided yields below 2%. Another possibility would be utilities and related ETFs, including SPDR Select Sector Fund Utility ETF (NYSEARCA:XLU). The key question would be whether they can deliver enough stock appreciation. While XLU might provide significant dividends, most of the current JNJ position is from capital appreciation. A variation would be to look for utility like companies in emerging markets to combine dividends and growth.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.