It looks like the Federal Reserve is finally heading toward some interest rate hikes in 2022 or 2023. This will be welcome relief for investors that need some income. Still, bonds and bank savings accounts have proven inadequate for generating yield in recent years. As a result, income stocks are a great place to look instead.
It’s important to emphasize that passive income streams come from dividend growth. If you buy a stock that yields 6% today but it never hikes its dividend, it will still be yielding 6% in the future. Meanwhile, your real income would decrease over time as inflation takes its toll. On the other hand, if you buy a stock that yields 2% today but grows at 18% per year, by 2030, it will be yielding roughly 10% on your cost. And, not surprisingly, a company that can grow its dividend that quickly also tends to have a strong share-price performance.
In other words, when you’re thinking about a passive income stream, concentrate on how quickly it grows, not just how large it is at the beginning. As such, this list emphasizes companies that can quickly increase your dividend income over time.
The metrics I’ll use here are compounded dividend growth rate and yield-on-cost. Compounded dividend growth is the annual percentage increase that a company gives you over time. For a quick metric, consider that at a 10% growth rate, your dividend income doubles every seven years. At 15%, it doubles every five years, and so on. Second, we’ll consider 10-year yield-on-cost. This tells you the dividend yield you’d get today if you bought a given stock in 2011. This helps show the power of increasing dividends and passive income streams over time.
Companies that work best for this type of investing have large moats, operate in stable industries and have strong consumer brands. There are certainly exceptions, but those sorts of firms tend to lead the way. Here are 10 such income stocks that should reward investors with speedy dividend growth in future years:
- Hormel Foods (NYSE:HRL)
- Texas Instruments (NASDAQ:TXN)
- Mastercard (NYSE:MA)
- Starbucks (NASDAQ:SBUX)
- Lockheed Martin (NYSE:LMT)
- J.P. Morgan (NYSE:JPM)
- Northern Trust (NASDAQ:NTRS)
- Charles Schwab (NYSE:SCHW)
- Gilead Sciences (NASDAQ:GILD)
- Home Depot (NYSE:HD)
Income Stocks: Hormel Foods (HRL)
5-Year Compounded Dividend Growth Rate: 12.1%
10-Year Yield On Cost: 6.7%
Hormel Foods is a great example of steady, consistent dividend growth. Few people would look at a packaged-foods company like this as a rock star performer. Yet, management quietly grinds out roughly 10% earnings growth annually over the decades, and that translates into big dividend increases.
While HRL stock rarely yields more than 2% at the time of purchase, with 12% annual dividend increases, the passive income builds dramatically. A buyer of the stock in 2011 is now getting nearly 7% a year on their purchase. That’s pretty impressive for an extremely low-risk business such as this one.
Not only are the company’s meat, nut and Mexican cuisine products recession-proof, Hormel also has one of the strongest balance sheets in its industry. This allows it to take an aggressive posture and grow the business during economic downturns, such as last year’s pandemic. Hormel is just now making a big move into international markets, which should pave the way for at least another decade of steady, double-digit dividend growth.
Texas Instruments (TXN)
5-Year Compounded Dividend Growth Rate: 21.8%
10-Year Yield On Cost: 12.8%
Texas Instruments is one of the best dividend stories in the tech industry. Since the Great Financial Crisis, Texas Instruments has moved from an aggressive growth phase toward a mature growth and income posture. That means that while the analog semiconductor leader has slowed down its organic expansion efforts, it has now turned its prodigious cash-flow streams toward its shareholders.
Impressively, an investor that bought TXN stock in 2011 is now getting back 13% of their money every year in dividends. And the future looks bright. Thanks to the recent semiconductor boom, Texas Instruments has enjoyed huge demand for its products.
The company’s focus on chips for self-driving automobiles and Internet of Things (IoT) applications should continue to support its growth throughout the 2020s.
Income Stocks: Mastercard (MA)
5-Year Compounded Dividend Growth Rate: 19.1%
10-Year Yield On Cost: 6.4%
I know a lot of you are going to look at Mastercard, see the 0.5% current dividend yield, and think this is a crazy pick. But it’s actually a perfect example of how passive income streams grow over time. In 2011, MA stock was yielding a miniscule 0.2% per year. If you invested $10,000 in MA stock then, you would have gotten $20 in annual dividends. Not great.
However, that same investment is now yielding $640 per year in dividends. In other words, Mastercard boosted its dividend roughly 30x over the past ten years. It doesn’t hurt that the stock price went up hundreds of percent as well.
As a distinguished member of the credit card oligopoly, Mastercard earns huge profit margins while facing limited competition. The war on cash continues to drive more and more business to plastic effortlessly. And Mastercard’s management is intent on sharing its fortunes with shareholders. Sure, you’ll never earn much for buying MA stock today. But plant the seed, and it can grow into quite the tree over five or 10 years.
5-Year Compounded Dividend Growth Rate: 18.2%
10-Year Yield On Cost: 9.8%
Starbucks is precisely the sort of thing to look for in a dividend growth investment. It has a beloved brand around the world. It has tons of pricing power; few people care or even notice when Starbucks raises prices. And the company’s products — coffee and sweet drinks — translate well in most geographic markets.
In other words, Starbucks has a great product and a huge runway to keep growing. While Starbucks hit a hiccup a decade ago when it expanded too fast in the U.S., it has recalibrated now. The company’s growth efforts in markets such as China and Latin America are powering the next decade of dividend increases for Starbuck’s shareholders.
Income Stocks: Lockheed Martin (LMT)
5-Year Compounded Dividend Growth Rate: 9.6%
10-Year Yield On Cost: 12.9%
Not all dividend growth superstars exist in flashy consumer-facing industries. The defense industry, for example, has produced multiple big winners in this camp. Lockheed Martin is a great example. An investor that bought the stock in 2011 is now getting 12.9% of their money back each and every year as dividends. Additionally, the company is increasing the payout nearly 10% per year, adding to that passive income flow.
And the good times are just getting started for Lockheed Martin’s shareholders. Shares only trade at 14 times earnings right now. The stock sold off on concerns around President Joe Biden’s administration. However, it seems Washington isn’t going to cut defense spending much regardless. So there is a good chance for major share price increases in addition to the company’s consistently increasing income stream.
J.P. Morgan (JPM)
5-Year Compounded Dividend Growth Rate: 15.4%
10-Year Yield On Cost: 9%
For younger investors, it may seem crazy to buy bank stocks for reliable dividend income. After all, the Great Financial Crisis wiped out a fair number of venerable banks and caused many dividend cuts among the survivors. However, from the 1940s up through 2008, the banking sector was one of the most reliable and trustworthy sources of income. And they are reasserting themselves as large dividend growth stories.
J.P. Morgan is one such bank that has reestablished itself as a blue-chip stock. The bank offers a more than solid 2.4% starting dividend yield and has been increasing its payout at a healthy clip.
Due to the pandemic, the Federal Reserve put some stringent limits on capital return policies in 2020. However, these are expected to be loosened dramatically this year, making it possible for strong banks like J.P. Morgan to get back to increasing the dividend.
Income Stocks: Northern Trust (NTRS)
5-Year Compounded Dividend Growth Rate: 14.2%
10-Year Yield On Cost: 6%
Northern Trust is another such bank that has adapted well to the changing times. Northern Trust is a specialized bank focused on asset custody. This type of bank holds cash and securities for institutions such as pensions, governments and asset managers and collects a small fee for doing so.
Custody banks tend to be lower risk than traditional too-big-to-fail firms. Not surprisingly, Northern Trust made it through 2008 without too much damage and has gone on to reach new all-time highs since then.
Northern Trust was picking up momentum prior to Covid-19, as you can see with its healthy 14% annualized dividend increase rate over the past five years. As custody banks are big beneficiaries from higher interest rates, NTRS stock should prosper as the Federal Reserve enters a new rate hike cycle.
Charles Schwab (SCHW)
5-Year Compounded Dividend Growth Rate: 23.6%
10-Year Yield On Cost: 4.4%
That’s not a misprint; Charles Schwab has indeed grown its dividend more than 23% per year over the past five years. While its dividend yield is still fairly low now, the discount brokerage firm is clearly ramping things up as far as income investing goes.
Adding to that, the company’s business is looking better than ever. The stay-at-home period attracted unprecedented new investor interest in trading. Brokerages such as Charles Schwab scored a ton of business as a result.
And now, interest rates are surging. The Federal Reserve is talking about multiple rate hikes over the next few years. That’s fantastic news for Schwab. After all, it makes a bunch of its money from collecting interest on its customers’ cash deposits. As interest rates rise, Charles Schwab’s earnings should surge. That, in turn, will fuel further dividend increases.
Income Stocks: Gilead Sciences (GILD)
5-Year Compounded Dividend Growth Rate: 9.6%
10-Year Yield On Cost: 14.1%
Gilead Sciences has been a disappointing investment in recent years if you’re just looking for capital gains. From an income perspective, however, Gilead has been much more agreeable. An investor that bought GILD stock a decade ago is now getting 14% of their capital back annually.
Gilead’s fundamental problem is that it has had trouble finding the next big thing to replace its hepatitis treatment business. However, while that has limited stock price upside, Gilead needed to do something with all the cash flow from its blockbuster drugs. As a result, it’s been giving out solid dividend increases. At this point, the stock looks cheap and distributes nice income while offering an option on the company’s extensive drug pipeline.
Home Depot (HD)
5-Year Compounded Dividend Growth Rate: 19.7%
10-Year Yield On Cost: 18.7%
Home Depot is one of the most impressive passive income machines out there. A decade ago, an investor could have been forgiven for thinking that Home Depot was already a mature company heading for a slowdown. Instead, Home Depot has continued to put up dazzling returns.
Indeed, Home Depot has been growing the dividend almost 20% per year since 2016. And a buyer in 2011 is also pulling in 19% of their original purchase price every year.
At some point, Home Depot’s incredible growth will have to slow down. But we probably aren’t there yet. The pandemic caused a boom in home ownership and remodeling, which seems set to keep HD stock’s upward trajectory going.
On the date of publication, Ian Bezek held a long position in HRL, TXN, LMT, and GILD stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.