Many people invest in stable, low volatility stocks for the income, but investing in a dividend stock can actually lead to significant growth value as well.
If you’re investing in high dividend-paying stocks, you’re probably in it for the revenue stream it generates over time, something that’s commonly referred to as ‘Passive Income’.
The company you invest in will pay out your dividends over a specified period of time, based on the number of shares you have invested in the company. The more shares you own, the more you’ll get paid in dividends.
But what if your dividend stock that pays you regularly were to significantly appreciate in value over time, giving you a substantial increase in your asset value? I’ll take that! And you’ll be glad to know that this is actually quite a common occurrence in the stock market.
Today we’ll explore why this happens and what in particular contributes to that, and why you, as a dividend investor, should be looking at this.
Earnings Per Share (EPS)
This is basically how much money a company makes for each share of its stock. Higher EPS is a widely desired metric by companies and investors alike, as a company with higher profits is a company that can pay out more to its shareholders, so you can expect dividend growth over time.
A useful way to look for this is to look at a company’s dividend history. Take a look at it’s dividend payouts over time and it’s Earnings Per Share. You’ll notice that if Earnings Per Share is rising, the subsequent dividend payouts will increase as well.
Dividend paying companies will look to do this steadily over time, as it gives investors confidence in the growth of the company and their investment. This leads me on to the next calculation to look for. Earnings Per Share Growth.
EPS Growth
EPS growth over time suggests that the company is on an upward trajectory, and it’s products or services are in strong demand. Earnings growth is even considered essential to a stock’s success and has the greatest impact on its future price performance.
This is a fairly straightforward calculation, take the Earnings Per Share and subtract it by the number that preceeded it 12 months ago.
For example if a company’s EPS was reported at £1.25 this year compared to it’s previous years EPS of £1.00. Then we subtract the current year value from the previous year to give the growth. This is expressed as a percentage, and so is calculated by divding it by the previous year’s EPS and multipled by 100, giving an EPS growth rate of 25%.
If you were to spot a company with a reported EPS growth rate of 25% year on year, this would be a highly attractive investment, as your expected dividend payments would look to increase steadily over time. In turn, this would drive up the price of the shares.
If you had an investment in a company such as this, you’d realise significant growth in the stocks value, and your intial investment would raise in value over time. Let’s look at an example in history where this has proven to be highly successful for investors.
Merck and P&G
To look at this in action let’s go back to 1960 and look at 2 separate dividend-paying stocks. Procter & Gamble, which as paid dividends every year since 1891, and Merck, which has paid dividends every year since 1935.
What a track record to hold for both of these firms! Imagine you thought it would be best to put some of your cash to use wanted to get into investing.
You looked at their consistent dividend paying history and thought the steady stream of income you’d get would be a positive financial step forward, so you invest $1,000 in each of these companies back in 1960.
What you may not have considered was how much growth these firms would see over the next few years. Let’s look at what your investment looked like 30-years later in 1990.
Over that time period. P&G averaged an Earnings Per Share Growth of 8% per year, while Merck averaged a staggering growth rate of 14.8% per year!
Due to the massive earnings growth, your investment of $1,000 each was now worth more than a combined total of $51,000! This just goes to show the power of time when investing.
Since these great companies were given such a long time to grow their business and share value, you would have seen an immense rise in asset value. But wait, it gets better.
To put this into perspective, let’s have a look at what your dividend payments would have been in the year 1990. From an initial investment of $1,000, you would receive an annual dividend payment of $222 from P&G, and $894 from Merck. That’s over 50% of a return on investment.
The dividend payments over time have massively outgrown his investment value back in 1960, and you continue to get that steady stream of income passively.
Summary
This really goes to show that when investing you should be in it for the long term to realise those massive benefits. If you look at the market over time, history tells us that investments do well over a longer duration of time.
While you may realise losses in the short term like we have seen in recent months, going against the market and not selling when everyone else is can really pay off. In fact, investing when everyone else is selling can give you the ability to buy great companies at a discount.
As one of the greatest investors of all time, Warren Buffet said “You should be fearful when others are greedy, and greedy when others are fearful”.
At the end of the day, the stock market is a massive sum of transactions between human beings, and humans are led by emotion. Fear can run rampant through the market, causing wild overreactions and mass sell-offs. Don’t let your investment strategy be guided by emotion!
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