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Enjoy the Power of Dividend Compounding

It's a strong yet often-overlooked element in income investing

   

Are you a dividend investor? Many people are these days, given record low interest rates. RPM International (NYSE:RPM), a producer of specialty chemicals, recently brought into focus for me a very important aspect of dividend investing — compounding — which can supercharge your investment portfolio. Using several examples of Dividend Aristocrats (companies that have increased their dividends every year for at least 25 consecutive years, which includes RPM International), I’ll demonstrate how.

RPM International has increased its dividend for the past 38 years in a row, one of only 46 public companies (out of 19,000) to do so. Its current yield is 3.2%, based on a quarterly dividend of 21.5 cents.

In a recent Credit Suisse conference presentation, the company illustrated how the power of compounding, dividend reinvestment and an increasing dividend work together to deliver superior shareholder return. It went on to suggest that shares acquired 20 years ago were now yielding 18.2% and those bought a decade ago a very healthy 7.8%.

Since 1975 through 2011, RPM has paid $1.4 billion to shareholders in the form of dividends. Through the end of May, it has outperformed the S&P 500 over the last decade by 64% and its peers by 28%. It has spent $306 million on dividends in the last three years compared to just $31 million for share repurchases. Buybacks, in my opinion, are usually a waste of money because companies tend to overpay. It’s clear that this company understands capital allocation.

RPM International is part of the S&P High Yield Dividend Aristocrats Index, which takes the highest-yielding stocks from the S&P 1500 that have increased their dividend for 20 consecutive years. My other examples will also come from the index’s holdings. For those who don’t want to own individual stocks, State Street (NYSE:STT) offers the SPDR S&P Dividend ETF (NYSE:SDY), which seeks to replicate the performance of the index, and has a reasonable annual expense ratio of 0.35%.

First up is Avon Products (NYSE:AVP), the No. 1 representative in the index. Its stock gained over 7% Oct. 5 on the news former CEO and current chairman Andrea Jung is leaving the company at the end of 2012. As of Monday’s close, Avon is yielding 5.3%. Jung joined Avon in 1994, and within five years became its chief executive.

Over the next five years, it seemed Jung could do no wrong, and AVP jumped 213%, hitting an all-time high of $46.65 in July 2004. It’s been downhill ever since.

Over the last 10 years, Avon’s dividend has grown at a compound annual growth rate of 9.2%. But in 2012, it announced that its dividend payout would match that of 2011, ending 22 years of consecutive increases. In Avon’s case, the stock has basically tread water in the past decade, so the yield on the original cost is virtually the same as its current yield. That’s not what you want to see as a long-term investor.

For our purposes here, the best illustrations of compounding dividends will come from the smallest weightings in the index. This is because the largest holdings are companies, like Avon, whose stock prices have fallen to such an extent that they’re the highest-yielding of the S&P 1500. RPM International is the 57th-largest holding out of 82. Its 10-year total return through Oct. 8 is 9.18%, 83 basis points higher than the S&P 500 and 875 basis points higher than Avon.

One of the best-performing stocks from the benchmark over the past 10 years is Sherwin-Williams (NYSE:SHW), the paint people. Its annual total return as of Oct. 8 is 21.65%, 2.6 times the S&P 500. With its stock up 72% year-to-date, its current yield is just 1%.

However, the yield on an investment made on December 31, 2001, is 6.4%, which takes into consideration reinvested dividends. By purchasing its shares a decade ago and holding, shareholders have improved the income portion of their total return by 540%. That’s the beauty of compounding.

A second example of the power of compounding is VF (NYSE:VFC), one of the best apparel companies anywhere. Its 10-year performance on an annualized basis is 18.46%, with a current yield of 1.80%. However, its yield on an investment made on December 31, 2001, is 8.49%, 209 basis points higher than an investment made on the same date in Sherwin-Williams.

The reason for the difference? VF’s dividend compounded at an annual growth rate of 10.9% over the past decade, 120 basis points higher than Sherwin-Williams. Time combined with growth equals higher returns.

“Compound interest is the most powerful force in the universe,” is a quote frequently attributed to Albert Einstein. The physicist likely didn’t make this assertion, but that doesn’t take away from the premise. Buy-and-hold investing has come under attack in recent years.

However, companies such as RPM International, using the power of compounding, dividend reinvestment and dividend growth, demonstrate why holding quality stocks over the long haul still makes sense.

As of this writing, Will Ashworth did not own a position in any of the stocks named here. 


Article printed from InvestorPlace Media, http://investorplace.com/2012/10/enjoy-the-power-of-dividend-compounding/.

©2014 InvestorPlace Media, LLC

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