The end of the year is a perfect time to reflect on your investment journey. Part of that reflection can involve identifying mistakes worth avoiding or portfolio moves to make before the end of the year. You can also dig deeper into a particular sector or type of stock, such as growth stocks versus value or dividend stocks.
There’s no force more powerful in the stock market than earnings growth. Earnings growth can make a company that looks expensive based on trailing earnings still worth buying. It can create a snowball effect for accelerating shareholder value by compounding the pace of innovation, dividend raises, buybacks, mergers and acquisitions, and more.
Income investors often look for companies that sport track records of routinely raising their payouts. However, that can be expensive and ultimately damaging if a company isn’t growing earnings. For example, suppose a company is passing along all of its profits to shareholders through dividends, but it continues to take on debt. That can damage the company’s health and, ultimately, make it a bad investment.
The best dividend-paying companies can grow their earnings at least as fast as their dividend payment. Procter & Gamble (NYSE: PG) is a Dividend King with 68 consecutive years of dividend increases — an impeccable track record. Over the last decade, P&G has increased its diluted earnings per share at a slightly faster rate than its dividend. It has been able to buy back a considerable amount of stock to reduce its share count by 12.8%.
Growing earnings and dividends have justified an increase in P&G’s value. Investors who have held P&G stock for the last decade have enjoyed a 92.3% increase in the stock price. However, the total return (factoring in dividends) is much higher at 155%. P&G is a good example of how a company with wonderfully mediocre earnings and dividend growth can be an excellent investment because of consistency.
Consistency is a key attribute to remember when approaching dividend stocks. Investing is all about trade-offs. Growth stocks offer better potential for outsized gains, but can be volatile and inconsistent. Investors often gravitate to dividend stocks because they’re looking for something more predictable that aligns with their financial goals or risk aversion, or because they’re looking to supplement income in retirement. Often, the best dividend stocks are also the most consistent.
Dividend yield is a company’s annual dividend payment divided by its market cap, or more simply, dividend per share divided by the price per share of the stock. The yield will go up if dividend raises outpace the stock price, and down if the stock price exceeds the dividend growth rate. The best combination is a company that consistently raises its dividend by a sizable amount and grows in value — creating a greater shareholder return driven by capital gains and dividends instead of just dividend income.
There are plenty of excellent dividend stocks with low yields because their stock prices have gone up considerably. A surprising recent example is Walmart (NYSE: WMT). Walmart is a stable, industry-leading company that’s also a Dividend King. However, the stock is up a staggering 88.3% in the last year. Walmart’s long-term investments are paying off, and it is taking market share during a time when many of its peers are struggling. The run-up in Walmart stock has pushed the yield below 1%, so Walmart is no longer a viable source for generating sizable passive income. But that doesn’t mean Walmart isn’t committing to growing its dividend.
Costco Wholesale (NASDAQ: COST) is another retailer that has consistently produced outsized gains compared to the market. Costco is a unique case because it has a small ordinary dividend, but sometimes pays large one-time special dividends when its cash position reaches a healthy level. It’s Costco’s way of returning money directly to shareholders through dividends. Once again, Costco isn’t a good option if you’re looking for stable and consistent quarterly dividend payments, but it’s highly committed to using dividends to return capital.
You may know Sherwin-Williams (NYSE: SHW) as a paint company. It’s also a high-octane stock that continues to crush the broader market. Sherwin-Williams has had an incredible year. In February, it hiked its dividend by 18.2%, marking the 45th consecutive annual increase. In November, it joined Nvidia as the latest additions to the Dow Jones Industrial Average.
Over the last decade, Sherwin-Williams has more than tripled its dividend, but the stock price has quadrupled. Sherwin-Williams may yield just 0.7%, but its shareholders don’t mind one bit given the epic gains.
Microsoft (NASDAQ: MSFT) pays more dividends than any other U.S.-based company. Over the last decade, Microsoft has hiked its dividend by around 8% to 11% per year like clockwork, while also buying back enough stock to more than offset its stock-based compensation expense. But because the company is worth so much and has been growing in value faster than it is raising its dividend, the yield is only 0.8%.
Walmart, Costco, Sherwin-Williams, and Microsoft no longer yield a decent amount if you went out and bought the stock today, so they should be viewed more as growth stocks than value or income stocks. However, they have much higher yields on costs for long-term investors.
Yield on cost is, in my opinion, a concept that gets far too little attention when discussing dividend stocks. Yield on cost is the simplest way to not punish a company for being a strong-performing stock. Instead of taking the dividend per share and dividing it by the current share price, you take the dividend per share and divide it by the price you paid for the stock.
As an example, let’s say you bought Sherwin-Williams five years ago for $192.85 a share, when the stock had a quarterly dividend of $0.377 per share. and Microsoft for $151.75 per share, when it had a quarterly dividend of $0.51 per share. At the time of this writing, Sherwin-Williams has a stock price of $384.96 per share and a quarterly dividend of $0.715 per share, and Microsoft has a share price of $443.57 and a per-share quarterly dividend of $0.83.
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Company
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Hypothetical Cost Basins
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Current Share Price
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Current Annualized Dividend
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Current Yield
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Hypothetical Yield on Cost
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|
Sherwin-Williams
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$192.85
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$384.96
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$2.86
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0.74%
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1.5%
|
|
Microsoft
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$151.75
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$443.57
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$3.32
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0.75%
|
2.2%
|
Data sources: YCharts, Yahoo! Finance.
Based on the amount of money you invested in each stock five years ago, you would be yielding 1.5% on Sherwin-Williams and 2.2% on Microsoft — far higher than the current dividend yields. If you did the same exercise, but assumed that both stocks were bought 10 years ago, the yield on cost for Sherwin-Williams would be 3.4%, and Microsoft would be a whopping 7%!
So that initial investment in both stocks would be producing a considerable amount of passive income, in addition to the gains made from the increase in the value of both companies.
When it comes to dividend investing, it can be easy to get enamored by a high yield. While some high-yield stocks are certainly worth a closer look if the company is showing signs of turning things around, it’s important to take a step back and focus on dividend investing fundamentals. A dividend is only as strong as the company paying it. So you should first and foremost invest in companies you believe in. From there, see if they have a quality dividend (not the other way around).
By staying consistent and applying these core concepts, you can build a strong and growing dividend portfolio focused on quality rather than quantity.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale, Microsoft, Nvidia, and Walmart. The Motley Fool recommends Sherwin-Williams and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
3 Lessons Dividend Stock Investors Can Benefit From in 2025 was originally published by The Motley Fool
