Dividend Growth Investing For Millennials

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Includes: AAPL, AMZN, ARCC, FB, GOOGL, IBM, JNJ, O, SBUX, T, TSLA, V
by: Income Machine

Summary

Without the need for current income, where can millennials turn to produce outsized returns?

How compounding can work without purchasing dividend paying companies.

The key to the equation is buy and hold. That's the glue that binds the wisdom of dividend reinvestment and the prospect of increased equity in growing businesses.

Lately, I've been pumping iron twice as long at the gym than usual in preparation for a wedding in California this weekend. My buddy from college is finally getting hitched and I know that the rest of his crew are doing the same. It will be a bunch of boasting, roasting, and phony bravado and a helluva lot of fun to compare how out of shape we are today (entering our 30s) compared to where we were a tad over a decade ago. We went to San Diego State and it was no surprise when he threatened no one was getting out of a pool party he's throwing the day before the big day. I chuckled at his email: "Bring your bathing suits big boys - and suck those bellies in." The years put the 'pound' in compounding.

I'm sure most of us are a bit more… robust (that's a nice term for it) than we were at 20, but who can say the same about their investment accounts? With weddings, down payments, student loans and babies on the way or already crawling around, some data points to a dismal savings/investment rate.

My millennial peer group gets a bad rap for our 'everyone-deserves-a-trophy attitude' and our lack of savings. But a lot of that is generated from old cranks who don't know us very well. And hey, it isn't our fault our folks distributed trophies to everyone! And I would say it's been pretty darn lucrative for my PSA preferred shares where those trophies collect dust.

Many of us have invested tens of thousands into our degrees and careers, and a sizable group younger than 30 are serious about investing. For this group, investment approach is often discussed. Invest in growth or dividends? High present yield or high future yield? Do dividends matter or should we jump on the SNAP and Google bandwagon as platforms for the future?

On one side of the fence is the opinion that millennials can afford more risk and should accept lower/no dividends since they don't need the income right away. Tesla (TSLA) shares spawn no dividends and neither do Facebook (FB). Yet both companies are experiencing significant revenue growth and have much more room to grow. Alphabet (NASDAQ:GOOG) (GOOGL) is another stalwart which will likely return some free cash flow to shareholders down the road but perhaps not for many more years.

Another thought is to blend a mix of growth with current income. Starbucks (SBUX) comes to mind as a company that has a pleasant mix of moderate growth and a reasonable current yield. Another compelling option is Apple (AAPL) which currently pays sub 2% but is committed to a 10% dividend growth rate each year. The yield-on-cost for shares purchased today will be much heftier in the future. And we all know how Millennials love to frequent those coffee shops with their Macs. That's one stereotype there's no avoiding. Visa (V) is a third choice which has been around forever and still has substantial growth ahead offering a nominal yield of .75%.

Source: Image

A third approach is to buy the established dividend aristocrats or those mature companies that have proven themselves compelling dividend stocks over decades. International Business Machines (IBM) comes to mind paying 3.3%. Coca-Cola (NYSE:KO) is another wonderful choice distributing $1.48 each year good for 3.5%. It's hard to go wrong with blue chips like Johnson & Johnson (JNJ) which yields over 2.5%. These companies offer mild growth rates but dependable rising dividends year after year.

Yet another option is to stretch a bit more to juice the yield. REITS, BDCs, telecoms and utilities come to mind as an immediate splash of income. Here, a baseline yield is about 4% or double that of the S&P 500 (below). AT&T (T) is paying 4.9%. Ares Capital (ARCC) is paying a whopping 8.7%. Realty Income (O) is distributing $2.53 annually or over 4%.

Source: simplywall.st

And then you have the often overlooked potential of gobbling up bonds and preferred stock. The Federal Reserve seems keen on rising rates modestly, so the potential for 6-7% investment grade notes will become more plentiful within the next 12-18 months. These notes are unlikely to generate strong capital returns (and some will have you lose principal if you purchase over par). However, the interest payments will continue despite price fluctuation of the issuance. December 2016 was a great opportunity to buy when the 10-year Treasury Note bolted north. There are more opportunities on the horizon.

So, which one is the ideal strategy for the astute millennial investor?

First, we need to identify the underlying trend that all these strategies have in common for maximum impact… buy and hold. Compounding only occurs without the friction of selling and churning of your portfolio. At first glance, it may appear that buy and hold only works with dividends… however, non-dividend payers can offer a modified option. Let me show you how.

The purpose of dividend reinvestment is to increase one's share count and equity stake in the company. That is a (mostly) foolproof strategy when purchasing blue chip stocks. So how can one get more shares from a company that doesn't pay dividends (without purchasing more)? From splits. Let's look at Amazon (AMZN) as a case study. Amazon pays no dividend, but if you employed the tried-and-true buy and hold approach, your stake in the e-commerce behemoth would be much higher than it was initially.

Source: Image

Hard to believe that's only a 10-year graphic above (about the same period from my college graduation). Amazon experienced 3 splits since 1998. The first split for AMZN took place on June 02, 1998. This was a 2 for 1 split, meaning for each share of AMZN owned pre-split, the shareholder now owned 2 shares. For example, a 1,000 share position pre-split became a 2,000 share position following the split. AMZN's second split took place on January 05, 1999. This was a 3 for 1 split, meaning for each share of AMZN owned pre-split, the shareholder now owned 3 shares. For example, a 2,000 share position pre-split, became a 6,000 share position following the split. AMZN's third split took place on September 02, 1999. This was a 2 for 1 split, meaning for each share of AMZN owned pre-split, the shareholder now owned 2 shares. For example, a 6,000 share position pre-split became a 12,000 share position following the split.

Share count rose from 1,000 to 12,000 during this period. And yet the owner of the shares received no dividend checks and therefore no reinvestments were made. So don't let the diehard buy and hold dividend growth investors deter you from another way to compound your money. Emphasize the buy and hold half of the equation is what's important.

Most of us blokes are not prescient enough to predict the next Amazon, but we can do our best to allow compounding work in our favor via buy-and-hold for the stocks we do select.

There is no uniform answer to my question because each millennial has different goals and ambitions. For example, a frugal 25-year-old may want to retire early with dependable income. It would probably make sense to weight the higher yield side of the equation for him, since he would have to sell their Amazon type shares if they took the growth approach upon their early retirement.

Conversely, a millennial doctor who wants to donate $200,000 to charity when she turns 60 may want to focus more on growth companies (low or non-dividend payers). Taxes from interest payments would be enormous (had she bought bonds), and this individual doesn't need current income since she is earning plenty through her career. If she journaled the shares to charity, they would receive a stepped up cost-basis and taxes would be minimal.

I can think of many other scenarios which require individualized approaches. Any millennial readers: feel free to post your approach in the comment section below.

Conclusion:

No matter which stocks you select to align your investments with your personal life goals, a common thread is to buy and hold and let compounding work to your advantage. Most millennials are ages 25-35 and they have a good 35 years before they knock on the door of Social Security (or what's left of it as the boomers clean us out!). By that point we will be yelling at the youngsters lamenting, "Kids these days. When I was growing up we all got plastic trophies. Now they want them made of silver!"

When my buddies and I celebrate the wedding this weekend, I am hopeful that our pocketbooks are as heavy as our bellies. There will be no need to suck those in.

Disclosure: I am/we are long KO, AAPL, TSLA, T, IBM, PSA.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.