News Analysis date published New: 
Monday, July 2, 2012 - 13:00
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Monday, July 2, 2012 - 13:00
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Monday, July 2, 2012 - 13:00

The ONE Thing That's More Important Than High Yields

Monday, July 02, 2012 1:00 PM

For income investors, one of the first criteria considered when making an investment decision, especially if you're a dividend investor, is a stock's dividend yield. And why not? After all, if the whole point is to generate income, then why take on a low-yielding position when a higher-yielding one is readily available?

Yet, there's more to consider than just the current yield.

Though not readily apparent, sometimes stocks with strong yields right now may have surprisingly stagnant dividend growth going forward. Take Merck (NYSE: MRK) for instance. Though the 3% yield Merck shares were offering in the middle of 2002 was solid at the time, the quarterly dividend payout of $0.42 per share now is only six cents better than the $0.36 per share payout investors were booking in each quarter of 2002. It took the iconic drug company a decade to ratchet up its dividend by a mere 16%, and the bulk of that increase only happened as of the end of 2011.

In other words, investors who thought Merck was going to provide steady income growth not only missed out on capital appreciation from the stock, but even missed out on growing their income stream.

Moral of the story: Look for companies that consistently raise dividends, even if yields seem a little sub-par at the moment. Here's a trio of dividend names with a long history of increased payouts than income-seekers may want to consider.

1. United Parcel Service (NYSE: UPS)
Current yield: 2.3%

Though the shipping business may have stumbled a bit in early 2008, it never really dried up, and United Parcel Service was close to its peak earnings levels again by 2010. That's how it's managed to continue cranking up its dividend, only stalling -- though not dropping -- for a couple of quarters in mid-2008 when the financial crisis was at its worst. In fact, UPS may have one of the market's most underappreciated dividend growth track records, from a quarterly payout of $0.19 per share in 2002 to $0.57 per share now.

Crunching the numbers, with a $10,000 investment in United Parcel Service at this point in the year in 2002, shares would now be worth $12,733 and owners would have received dividend payments totaling up to $2,532. That's a 52% return on the whole investment, nearly half of which was the result of dividend growth.

Though the current dividend yield is a little more than 2%, for investors who bought the stock in 2002, their effective yield -- based on their cost basis -- is actually 4% and rising.

2. Coca-Cola Enterprises (NYSE: CCE)
Current yield: 2.4%

Coca-Cola Enterprises, the bottling and distribution outfit for Coca-Cola products in much of Europe, has pumped up its dividend payout every year since 2005, and hasn't decreased it since at least 1996. It's been a hearty improvement since 2005 too, from a quarterly payout of $0.04 per share in 2005 to $0.16 per share now.

At the same time, investors have also enjoyed some capital gains since 2002. A $10,000 investment in Coca-Cola Enterprises in the middle of 2002 would now be worth $12,051, and during that time shareholders would have pocketed $1,304 in dividends. That's a total return of 33.5%, largely thanks to a quadrupling of the payout.

3. 3M Co. (NYSE: MMM)
Current yield: 2.7%

No need walk through the thought process again -- let's just crunch the numbers. A $10,000 investment in 3M back in mid-2002 would now be worth $14,173. Given how 3M has upped its quarterly dividend from $0.31 per share then to $0.59 now, shareholders would have cashed-in $2,985 worth of dividend checks during that timeframe. That's a total return of 71%, easily topping the broader market's 36% return during that period.

Better still, though the dividend yield is 2.7% for newcomers to the stock, those who've patiently held onto it for a decade are now getting a 5.2% effective yield on their investment.

Risks to Consider: As is the case with any dividend, there's no outright guarantee these or similar stocks will continue to increase the payout, or even pay them at all. Then again, these three stocks have a 10-year track record of rising dividends.

Action to Take --> These three stocks are just a few among many that pair the power of earnings growth with the benefit of rising dividends, which can be a nice hybrid of pure growth and pure income strategies.

Among the three stocks I've mentioned, 3M may be the ideal one to start with. It's actually shown the weakest dividend growth among these three stocks, but it's also the one with the most potential for earnings growth from which to pay higher dividends. In fact, the trailing 12-month profit of $6.06 per share is an all-time high for the company, and its estimated earnings growth of 5.1% is the best in this particular bunch.

And don't forget... The power of compounding can really take over when you reinvest dividends, potentially raising your total return even higher. This is exactly how Amy Calistri is able to pocket $1,357.52 in dividends a month, on average, in her Daily Paycheck newsletter portfolio. [If you haven't learned more about her excellent newsletter, I highly encourage you to do so by clicking here. You won't have to sit through a long video, either.]

James Brumley does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.