Are you seeking the best dividend yields of 2016? Thats a good idea, but I reckon what we should really be looking for is the great dividends of future years 2020, 2025, and beyond. And the secret to that is not big yields today, but progressive yields that are very well covered and should be easily supported by future earnings.
And thats why I think ace growth stock ARM Holdings (LSE: ARM) should turn into a future dividend darling and you can lock in future yields by buying the shares today. With the company on a forecast yield of only 0.7% for 2015, you might think Im mad, but please bear with me.
There are two important things here. Firstly, the 0.7% yield thats on the cards for this year would be around 3.7 times covered by earnings (compared with only around 1.5 times for some of our top FTSE 100 yields today), and those earnings have been growing rapidly and are set for a further 67% rise this year.
Progressive is best
And ARMs dividend policy is progressive the interim dividend this year was boosted by 25%, the mooted full-year payout would represent an 18% rise over last year, and that follows rises in previous years of 23% (2014), 27% (2013) and 29% (2012). And ARMs dividends have been rising way above inflation since the company first started paying them in 2003.
Looking back a decade, in 2005 ARMs dividend came in at just 0.84p per share. With 8.3p per share expected this year, the dividend has multiplied almost tenfold in ten years. Back then, with the shares trading at around 125p, youd have had a yield of just 0.7% but if youd bought the shares and held them, youd be on for a yield (based on your original purchase price) of 6.7% this year.
Of course, over that period the share price itself has soared eightfold to around 1,050p, and thats kept the annual dividend yield at less than 1% but you shouldnt let that hide the remarkable dividend rises and the massive effective yield that last decades investors are enjoying today.
The next decade?
So what of the future? Well, if ARMs dividend keeps on growing by 20% a year, wed be looking at around 21p per share by 2020, and on todays share price, that would provide an effective yield of 2% not massive, but still 2.5 times better than this year. And in another decades time, 2025s dividend would have grown to a very impressive 51p per share, providing a yield of 4.9% on todays price.
And what about those investors who bought ARM as a growth share in 2005 and will keep them for the 20 years until 2025? Well, even ignoring the share price growth they will surely have enjoyed, theyll be pocketing a dividend yield of 41% on their original purchase price!
From growth to maturity
Of course, ARMs earnings growth must eventually start to slow, although I cant see that happening for some time yet. But even when that day comes the company should be well on the way to becoming a high-yielding cash cow, converting a significantly bigger proportion of those earnings into dividends every year.
And the real lesson is that we shouldnt be blinded by todays dividend yields, but we should be looking for companies that will be able to keep lifting their dividends well ahead of inflation in the years to come.
Investment strategies come and go, but it’s hard to beat the idea of putting your money into top dividend-paying companies with progressive cash-handout policies, which have the potential to lift your income year after year. Our newest report, A Top Income Share From The Motley Fool, reveals a company that might just fit that bill.
It’s a company with a market cap of around 500m, so it’s not a high-risk tiddler, and dividends have been growing very strongly over the past few years.
Want to know more? Click here to get your completely free copy of the report delivered to your inbox today.
Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended ARM Holdings. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.