To kick off the new year, let’s take a step into the “Way Back Machine.” We won’t get carried away with ourselves and go too far back (long New Year’s Eve night and all that)—only ten years to the January 1st start to 2004.
At that point in time, you were looking to make an investment with $25,000. Maybe you inherited it, maybe it was a bonus, maybe you sold an asset or business, or maybe you put together the money through some good old-fashioned saving.
As you come across some potential investment ideas, you decide to take a hard look at Colgate-Palmolive. Everyone knows how lucrative toothpaste, soap, and other toiletries are. The company slaps brand names on its goods like Ajax, Irish Spring, Hill’s, Soft Soaps, Fab, and of course, Colgate and Palmolive, and it is able to achieve 36.0% returns on total capital because of the price that people like us are willing to pay when we walk through Wal-Mart and pick out our deodorants, soaps, and toothpastes off the shelves. The company has earned its brand name recognition that has allowed it to occupy shelf space in the bathrooms of most Americans: you may not think of toothpaste as an innovative industry, but Colgate is currently breaking ground on an anti-cavity toothpaste that uses remineralization techniques to neutralize the sugar deposits in teeth and be 4x as effective as the typical fluoride.
Despite this apparent business quality, the stock never appears to be especially cheap; most of the time, it trades between 18x and 22x the profits it generates. It’s not really the kind of stock that you can ever get on sale, short of once-in-a-generation events like the bear market of ’73 or the recent financial crisis in 2008 and 2009. When looked at the stock in 2004, you would have seen that the company was trading around $25 per share for most of the period, and had paid out $0.45 in dividends while creating $1.23 in toothpaste and soap profits for its shareholders.
That’s a 1.8% dividend yield and a valuation around 20-21x earnings. If you are someone interested in income investing, it could be easy to ignore a company like Colgate. After all, it’s not that hard to put together a portfolio of stocks yielding 5% or more if you put your mind to it (and this was back in 2004 when bonds, REITs, and bank stocks would have been offering a lot more immediate bang for your buck), and it’s easy to have a flippant attitude towards investments that yield 1.8% when your focus is on income.
But here is what is easy to overlook: with a company like Colgate, you get awesome growth in the dividend over long periods of time. Every year that you are patient, you get a dividend growth rate that triples the rate of inflation in good years, and doubles it in bad years. Toothpaste and soap has been such a dominant force that Colgate hasn’t missed a payment since making itself available for investment in the 1890s, and it has been going up every year for 50+ years.
That $25,000 investment would have bought you 1,000 shares ten years ago. At first, the dividend was only $450 in the first year. But now, as we sit here entering 2014, each Colgate share now pays out $0.34 per quarter—you are only a couple years of dividend hikes away from collecting as much every ninety days as you collected every year back in 2003. Those $450 annual dividend checks have grown into $1,360 annual dividend checks in exchange for your decade of patience. That $25,000 investment, which initially yielded 1.8%, now finds itself yielding 5.44%. And the $25,000 would have turned into $80,000, giving you $55,000 in untapped wealth you could convert into either a higher-yielding investment or consumption if the need arose (although people that truly experience dividend raises of 8-12% each year with a stock will know that they own a little money printing machine, and would rightfully express reluctance at the thought of selling an excellent business).
And none of this takes into account dividend reinvestment, which would have amplified your returns even further.
When you see low-yielding stocks like Becton Dickinson, Disney, IBM, or Colgate-Palmolive, it can easy to ignore them because the starting yield is so low. That’s the tradeoff sacrifice you have to make when you buy them—you only see $10,000 turn into $100-$200 of immediate income rather than $350-$550 of immediate income. But you get three things in return: you get reliability/predictability (toothpaste won’t be going anywhere soon), you get high growth of income (you get your 5.5% yield from Colgate, you just have to wait ten years, and you can shave some of that time off by reinvesting), and you get greater leaps in net worth (it’s not like Colgate will be offering investors a starter yield of 10% anytime soon, so as the dividend rises, the share price does as well over time). If you are willing to deal with low starting dividends from your common stock investments, your investing life can really open up. Colgate always looks like it’s just sitting there, yielding 2.0-2.5% all the time. But it creates so much more wealth than that.