5 Examples Of Dividend ‘Snowballs’ Generating Real Wealth

Investing in dividend growth stocks with strong competitive advantages subjects you to the ‘snowball effect’. What is the snowball effect? It is an analogy to get a practical feel for the wonders of compounding. Imagine your investment account as a small snowball at the top of a hill. You give the snowball a little push (add money to your investment account). As the snowball rolls down hill, it grows larger and larger, packing on ever more snow.

High quality dividend growth stocks are the same way. They compound value year after year, growing ever larger. Over time, your little snowball (or portfolio) becomes an absolute avalanche (money making machine). Calvin from Calvin & Hobbes gets it:

Real Life Snowballs Turned Avalanches

Not every dividend growth stock grows at a rapid pace indefinitely. For a successful portfolio, you don’t need them all to; only a few big winners will provide substantial returns. The 5 Dividend Kings (stocks with 50+ years of dividend increases) listed below all would have turned a snowball-sized investment into an avalanche of dividend income over the last 25 years. These 5 companies are:

• Coca-Cola  (KO)
• Procter & Gamble  (PG)
• Johnson & Johnson  (JNJ)
• Colgate-Palmolive  (CL)
• Lowe’s  (LOW)

Coca-Cola

If you had invested $1,000 in Coca-Cola stock back in 1990, today your total investment (including dividends) would have returned 1,398%; Investing in Coca-Cola at the start of 1990 would have turned, $1,000 into $14,979 (the 1,398% return + initial investment).

With a current dividend yield of 3.24%, your yield-on-cost would be 49% (yield on cost assumes dividends were reinvested). Coca-Cola stock would pay out your initial investment in dividends in about 2 years time. Coca-Cola is still growing. The company maintained an 11% compound annual growth rate over the last 25 years. With expected earnings-per-share growth of between 7% and 9% and a 3%+ dividend, the company will likely continue growing at about the same rate it has over the last 25 years.

Procter & Gamble

Coca-Cola has done well over the past 25 years. Procter & Gamble has done even better. The company’s investment returns since the beginning of 1990 are shown below:

• Total Return of 1,675%
• $1,000 would now be worth $17,754
• CAGR of 11.81%
• Yield-on-cost of 55%

Procter & Gamble currently has a price-to-earnings ratio of 24.2. The company is divesting its non-core brands to speed growth, which has slowed in recent years.

Johnson & Johnson

Johnson & Johnson has the lowest stock price standard deviation of any stock in the Sure Dividend database – even lower than utilities like Southern Company and Consolidated Edison. In addition, the company has increased adjusted earnings-per-share for an amazing 31 consecutive years. The company’s returns from 1990 to now are shown below:

• Total Return of 2,323%
• $1,000 would now be worth $24,226
• CAGR of 13.26%
• Yield-on-cost of 68%

Johnson & Johnson has performed exceptionally well over the last 25 years. The company’s yield-on cost of 68% in 25 years is extremely impressive. It is unlikely that Johnson & Johnson continues to compound shareholder wealth at 13% a year. With that said, the company could get double-digit annual total returns with its dividend yield near 3% and earnings-per-share growth projected to be between 5% and 8% year.

Colgate-Palmolive

Colgate-Palmolive’s success over the last quarter century is a result of its early adoption of globalization. The company has significant market share in toothpaste and dishwashing soap worldwide thanks to its aggressive international expansion.

• Total Return of 2,950%
• $1,000 would now be worth $30,502
• CAGR of 14.34%
• Yield-on-cost of 67%

Like Johnson & Johnson, Colgate-Palmolive is unlikely to continue compounding shareholder wealth at 14% a year. The stock currently has a 2.2% dividend yield and a price-to-earnings ratio near 30. I project a long-term earnings-per-share growth rate of between 5.5% and 8.5% going forward based on recent historical results and current international market growth. This gives the company total return potential of 7.5% to 10.5% going forward. I believe the company to be somewhat overvalued, which detracts from long-term total returns as well.

Lowe’s

Lowe’s performance over the last 25 years is truly extraordinary. The company is the number two player in the oligopolistic U.S. home improvement market. Very, very few companies can maintain a 20% compound annual growth rate over a 25 year period. That level of return is usually left to leveraged portfolios of super investors like Warren Buffett or Shelby Davis.

• Total Return of 10,541%
• $1,000 would now be worth $106,408
• CAGR of 20.25%
• Yield-on-cost of 131% (!)

Perhaps the most impressive aspect of Lowe’s growth is that it now has a yield-on-cost over well over 100% for investors who purchased the stock 25 years ago. Every year, Lowe’s is paying these investors more than their original investment amount.

With that said, it is extremely unlikely that Lowe’s generates a CAGR of 20% for shareholders over the next several years. The company’s rapid growth (together with Home Depot) has saturated the U.S. home improvement market. Growth will not be as easy to come by for Lowe’s over the next quarter century as it was over the last quarter century.