Are you a dividend investor seeking high yield?
If so, you most likely look at stocks whose yields are high going by the current stock price. There’s nothing wrong with this, provided you do your due diligence. However, there’s a much more effective way to get a high long-term yield, one that doesn’t require seeking out stocks with high, unsustainable payouts. By buying dividend-growth stocks, you can watch your yield grow over time, instead of buying a shaky “high-yield” name with poor dividend coverage.
In this article, I will explore one dividend stock that has both yield and growth in spades.
Enbridge
Enbridge (TSX:ENB) is a Canadian oil stock with a 6.4% yield at today’s prices. If you invest $100,000 at a 6.4% yield, you get $6,400 per year back in cash income (please note that we at the Fool prefer a more diversified portfolio and don’t recommend putting such a large sum into only one stock). On top of that, you can collect dividends that rise over time. Over the last 10 years, ENB’s dividend-growth rate has been 14.1%. If ENB can grow its payout by even half that rate going forward, then the payout for someone who buys today will rise to 10.2% within seven years.
Not only do rising dividends increase your yield; they increase the value of the stock, assuming investors are valuing stocks on dividend-paying ability. The “dividend discount model” is a way of valuing stocks based on expected dividends. To get a “justified price-to-earnings ratio,” you take
- Next year’s dividend;
- Divide it by year’s earnings; and
- Divide all of the above by cost of capital minus growth.
In this model, a stock’s valuation is derived entirely from dividends. Now, in reality, companies that pay no dividends at all are often very valuable: ultimately, it’s earnings that count — not whether the dividend is paid. However, dividends can serve as a good indicator of earnings quality if they rise consistently over time. So, they are worth thinking about.
How the dividend could climb to 10%
After hearing me say that Enbridge’s dividend could grow to 10%, you might be wondering how that can happen. It’s pretty rare to see financial data platforms quoting stocks at 10% yields. It happens occasionally, but not with giant companies like Enbridge. So, how’s this going to play out?
Truthfully, I don’t think that ENB will ever be quoted at a 10% yield. But if you buy the stock today, you might see a 10% yield on your shares in the future.
It comes down to a concept called yield on cost: that is, the dividend divided by the price you paid. If you pay $10 for a stock that pays $0.50 in dividends, you have a 5% yield. If the stock goes up to $20 and the dividend goes to $1, it still has a 5% yield for someone who buys at $20. But because you bought at $10, you get a 10% yield. That’s the magic of dividend growth!
Will it actually get there?
It’s one thing to say that Enbridge could get to a 10% yield but quite another to predict that it actually will. Enbridge already pays over 100% of its earnings as dividends, so it’ll need a lot of growth to justify a 60% increase in dividends. But as we all saw this year, oil is still very much in demand, so Enbridge’s pipelines are likely to be booked solid for the foreseeable future.
