MW How growing your dividends may work better than picking high-yielding stocks

By Philip van Doorn

Picking stocks with high current dividend yields can backfire, but high dividend growth rates are correlated with outperformance

If you need to generate income from your investments, selecting securities or funds based on their current interest or dividend payouts might solve the immediate problem. But a strategy of increasing dividend income might work out better over the long term.

There are many choices among mutual funds and exchange-traded funds for investors who want exposure to broad portfolios of companies that have increased payouts steadily or are expected to have the financial wherewithal to do so going forward. But some investors also want exposure to individual stocks.

Back in September, we explained why income hunters might be better served by dividend compounders than by stocks with high current dividend yields, by screening the S&P 500 SPX. The screen showed that if you had selected the stocks with the highest dividend yields five years earlier, most would have underperformed the index. A high current yield can be a warning - the stock's price has declined in part because investors have become less confident in the company's ability to maintain its dividend payout.

A group of stocks that started that five-year period with modest dividend yields but that increased the payouts significantly, meanwhile, tended to outperform the index.

For that screen of the S&P 500, we listed stocks with the highest compound annual growth rates for dividend payouts, excluding special dividends. The company that topped the list was Goldman Sachs Group Inc. $(GS)$, with a dividend CAGR of 28.01%.

Today we are repeating the screen, but with smaller companies that tend to be less widely covered than the S&P 500 - and the companies topping the new list show even higher dividend CAGR than those that topped the S&P 500 list.

Here is an example:

-- If you had purchased shares of Owens Corning OC at the close on Feb. 10, 2020, you would have paid $61.67 for the stock. At that time, the company's quarterly dividend was 24 cents a share, for an annual dividend rate of 96 cents. So the dividend yield on that day was 1.56%.

-- If you had held your Owens Corning shares for five years through Monday, your quarterly dividend would have increased to 69 cents a share, for a current annual payout of $2.76. The company's dividend has increased at a CAGR of 23.52% over the past five years. In comparison, the S&P 500's weighted dividend rate has increased at an estimated CAGR of 4.84% over the past five years, according to FactSet. The five-year dividend CAGRs have been 2.42% and 5.91% for the S&P Small Cap 600 Index SML and the S&P MidCap 400 Index MID, respectively.

-- The annual payout rate of $2.76 would make for a current dividend yield of only 1.53% for a new investor who bought Owens Corning for $180.14 at Monday's close. So the current yield is pretty much unchanged from five years ago. But if you had held the Owens Corning stock purchased five years ago, the yield on your five-year-old shares (based on what you paid for them) would be 4.48%. And your share price would nearly have tripled. And if you had reinvested your dividends, your total return for the five years would have been 216%, compared with respective returns of 96% for the S&P 500, 54% for the S&P Small Cap 600 Index and 68% for the S&P MidCap 400 Index.

Screening for small-cap and midcap dividend compounders

For the new screen of dividend compounders, we started with the components of the S&P Small Cap 600 Index and the S&P MidCap 400 Index and narrowed the list to 389 companies with dividend yields of at least 1.5% as of Feb. 10, 2020.

Then we looked at annual dividend rates going back six years to see if any had been reduced over the past five years. This brought our list down to 245 companies.

Among the remaining companies, these 20 have had the highest dividend CAGR over the past five years. You might need to scroll the table to see all of the columns, including the total return column on the right.

   Company                                Ticker    5-year dividend CAGR  Dividend yield on shares purchased 5 years ago  Dividend yield 5 years ago  Current dividend yield  5-year price change  5-year total return 
   Dick's Sporting Goods Inc.             DKS                     31.95%                                          10.06%                       2.51%                   1.86%                 441%                 535% 
   First BanCorp                          FBP                     29.20%                                           7.85%                       2.18%                   3.50%                 125%                 164% 
   Virtus Investment Partners Inc.        VRTS                    27.42%                                           6.52%                       1.94%                   4.85%                  34%                  55% 
   Nexstar Media Group Inc.               NXST                    27.13%                                           6.02%                       1.81%                   4.91%                  23%                  41% 
   Ovintiv Inc.                           OVV                     26.19%                                           7.33%                       2.29%                   2.70%                 172%                 217% 
   Owens Corning                          OC                      23.52%                                           4.48%                       1.56%                   1.53%                 192%                 216% 
   Innovative Industrial Properties Inc.  IIPR                    21.84%                                           8.26%                       3.07%                  10.29%                 -20%                   8% 
   Jefferies Financial Group Inc.         JEF                     21.67%                                           7.34%                       2.75%                   2.18%                 236%                 292% 
   Penske Automotive Group Inc.           PAG                     20.95%                                           8.10%                       3.13%                   2.45%                 230%                 265% 
   Preferred Bank Los Angeles             PFBC                    20.11%                                           4.81%                       1.93%                   3.33%                  45%                  69% 
   Patrick Industries Inc.                PATK                    19.14%                                           4.32%                       1.80%                   1.71%                 152%                 179% 
   Williams-Sonoma Inc.                   WSM                     18.89%                                           6.38%                       2.68%                   1.09%                 486%                 549% 
   East West Bancorp Inc.                 EWBC                    16.89%                                           5.07%                       2.32%                   2.45%                 107%                 135% 
   MGIC Investment Corp.                  MTG                     16.72%                                           3.67%                       1.69%                   2.08%                  77%                  98% 
   Hilltop Holdings Inc.                  HTH                     14.87%                                           3.22%                       1.61%                   2.25%                  43%                  57% 
   Westlake Corp.                         WLK                     14.87%                                           3.28%                       1.64%                   1.89%                  73%                  86% 
   Reliance Inc.                          RS                      14.87%                                           3.78%                       1.89%                   1.51%                 150%                 173% 
   SunCoke Energy Inc.                    SXC                     14.87%                                           8.30%                       4.15%                   4.90%                  70%                 110% 
   First Industrial Realty Trust Inc.     FR                      14.11%                                           4.04%                       2.09%                   3.24%                  25%                  41% 
   ServisFirst Bancshares Inc.            SFBS                    13.87%                                           3.41%                       1.78%                   1.48%                 130%                 150% 
                                                                                                                                                                                                       Source: FactSet 

Among the 20 small-cap and midcap companies with the highest five-year dividend CAGR, 13 beat the S&P 500's five-year total return of 96% through Monday, while 17 beat the S&P Small Cap 600 Index's return and 15 beat the return of the S&P MidCap 400 Index.

Click on the tickers for more about each company.

Read: Tomi Kilgore's guide to the wealth of information available for free on the MarketWatch quote page.

Don't miss: This stock fund is fully diversified from the S&P 500 - and pays high dividends

-Philip van Doorn

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February 11, 2025 10:54 ET (15:54 GMT)

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