According to recent research, an often-overlooked investment strategy of buying dividend-paying stocks and reinvesting the payouts could be the secret sauce behind the impressive long-term gains of the S&P 500 index.
The study by Hartford Funds revealed that a staggering 85% of the S&P 500’s mind-boggling 51,000% total return since 1960 can be attributed to the power of reinvested dividends compounding over time. This data underscores the wealth-building potential of a straightforward approach: purchasing shares of companies that distribute a portion of profits to stockholders and using those payments to accumulate more shares.
With this illuminating finding, we examine two long-standing dividend payers – industrial titan Caterpillar Inc. and retail behemoth Costco Wholesale Corp. – that may warrant consideration even at their currently lofty stock prices.
The Dividend Dynamo: Caterpillar Inc.
Construction equipment colossus Caterpillar has rewarded shareholders immensely over the past year with a 62% total return, including price appreciation and dividends. Remarkably, the company has paid a quarterly dividend for over nine decades and raised its payout annually for the past 30 years straight.
Today, Caterpillar’s quarterly dividend stands at $1.30 per share, translating to an annual yield of 1.45% on the current stock price. But the shareholder-friendly moves don’t stop there – management has also deployed billions to repurchase shares, boosting the ownership stake for existing investors by reducing the share count by 11% over five years.
On the operational front, Caterpillar generated record revenues of $67.1 billion and earnings per share of $20.12 in 2023, up 13% and 59% respectively from the prior year. These stellar results defied headwinds from elevated interest rates that have weighed on many sectors.
However, there are some potential clouds on the horizon. Order backlogs dipped from late 2022 to late 2023, and sales in the critical Chinese market have declined in recent years with further weakness expected in 2024. Still, the massive $1 trillion federal infrastructure spending bill from 2021 should provide tailwinds, and management forecasts 2024 sales to match the record 2023 levels.
Dividend sustainability is also a key consideration, analyzed through the payout ratio (annual dividends/earnings) metric. A ratio at or above 75% could strain a company’s ability to maintain payouts if earnings decline. Caterpillar’s modest 25% payout ratio suggests ample capacity to sustain and grow its prized dividend.
The Membership Model Marvel: Costco Wholesale Corp.
In the membership warehouse club arena, Costco has similarly delivered the goods with a 48% total return over the past year for stockholders. The company paid a recent special $15 per share dividend in addition to its regular quarterly payout of $1.16 (0.65% annualized yield on the current price).
Special dividends appear likely to keep coming based on Costco’s stellar balance sheet with $3.4 billion in net cash remaining even after that $6.7 billion outlay. This marks the fifth special dividend in 11 years from the discounter.
Fueling Costco’s success, price-conscious consumers keep flocking to the low-cost retail model. Paid household memberships rose 7.8% year-over-year to 73.4 million at last report, generating $2.2 billion in highly profitable membership fees for the first half of fiscal 2024, up 8.2%.
On the top and bottom lines, Costco posted $248.8 billion in trailing 12-month revenue, a 13.2% annual increase, along with $6.8 billion in net income, up 5.7% from the prior year. As of the latest quarterly update, the warehouse footprint stood at 874 locations globally, with ample room for further geographic expansion – particularly in burgeoning markets like China.
Speaking of China, while only operating six warehouses there currently, Costco’s membership base has already swelled from 10,000 to nearly 200,000 since debuting in the market in 2019. Costco plans to open 28 new locations worldwide in fiscal 2024 versus 23 net new openings last year.
Additionally, Costco has historically raised its membership fees every five years or so, last doing so in 2017. With over 73 million members currently providing around $4.7 billion in high-margin fee revenue, even a modest $5 increase could generate an incremental $360 million annually. Management has strongly hinted that another fee hike is inevitable, just a question of exact timing.
Costco’s primary imperfection lies not in its stellar operations, but a lofty earnings multiple with the stock trading around 46 times profits currently, above the five-year average of 39 times earnings. However, the late investing legend Charlie Munger, who served on Costco’s board, once stated he would buy the stock even at 44 times earnings in early 2022, calling it “a perfect damn company” save for the rich valuation.
The Verdict: Fortunes Favoring the Dividend-Focused
While skepticism is warranted anytime stocks have soared over a 12-month span, the fundamental strengths of companies like Caterpillar and Costco cannot be dismissed. These dividend-paying titans have cemented leadership positions in their respective spheres by delivering for customers across economic cycles.
For investors seeking to capitalize on the wealth-compounding prowess of reinvested dividends highlighted in the Hartford Funds research, these two stalwarts could represent compelling long-term opportunities despite their currently elevated stock prices. The siren song of dividend investing may be softly sung, but its potential to generate fortunes over decades is loud and clear.
