I love this chart.
It shows what happens if you had purchased and reinvested dividends in McDonald’s stock over the past two decades. For most of McDonald’s history, the initial dividend yield was terrible. As you can see in this picture, someone who purchased McDonald’s twenty years ago had to settle for an initial dividend yield of 0.9%. Understandably, a lot of income investors don’t get excited by that.
I mean that: it is understandable. If income is your game, you don’t want to set aside $10,000 to receive what amounts to a little over $8 per month in immediate income. That keeps your car washed for the year.
But yet, there is a subset of companies: IBM, Becton Dickinson, Disney, and Visa, to name a few, that automatically get written off by investors because they do not offer a promising initial dividend yield. Their appeal, though, is how fast they grow—and because future growth is presently invisible, it is easy to discount.
When you buy something like BP, AT&T, or Royal Dutch Shell, those companies are like three-foot tall saplings at the time of purchase—it is easy to see how they will grow into a dividend tree over time. With the IBMs and Visas, you are buying the stock in seed form from a dividend perspective, and so the initial trajectory of income seems slower. The appeal, though, is that fifteen to twenty years down the road, they have grown so much faster than all the other trees in the dividend forest that they end up generating much more income than you could ever imagined at the time of purchase.
When someone bought McDonald’s stock with a 0.9% dividend yield, who knew that within twenty or so years, you’d be collecting the full amount of your investment in dividend income alone every 36 months?
It’s not for everyone; particularly those that aren’t in a financial position to be patient in a decades-long way. From 1995 to 2002, hardly anything happened: the yield-on-cost of 0.9% only grew to 1.7%. That’s why people don’t do this stuff: not only is future dividend growth an inherently uncertain endeavor to begin with, but the first seven years of growth were negligible from a dividend yield perspective (and heck, this example assumes that you reinvested dividends).
But look at what happens once you hit 2011. All of a sudden, the yield-on-cost figure is moving by leaps and bounds, hopping to the tune of three percentage points per year. That’s why Alice Schroeder titled her Buffett biography “Snowball.” That imagery is particularly apt with the compounding of low-initial-yield/high-dividend-growth-rate stocks.
But I know that someone out there reading this is *thinking* in terms of decades, and to you, you will get the reward you deserve. It takes planning, an initial outlay of capital, and then years of reinvesting dividends with seemingly no jump in dividend yield on investment. Most people aren’t equipped for that. But look at what happens if you are one of the few that is.
Originally posted 2014-06-04 23:33:25.