Although it could be tempting to grab dividend stocks with high yields, your money would be safer if you explore stocks that don’t have the highest dividend yields. You’ll also lower your chance of dividend cuts by applying this general rule.
For any stock that offers a yield beyond twice the market yield, you should question the safety of its income. For your reference, currently, the Canadian stock market offers a cash distribution yield of almost 3.2%.
Ideally, you would have a long time horizon for your investments to grow. In this case, you can achieve your dividend dream by populating your diversified portfolio with dividend stocks that will increase their dividends over time to fuel your future income goal. Generally, dividend stocks that increase their dividends over time are safer and provide income that is more secure than stocks that don’t increase their dividends.
The combination of a good yield and income growth from a stock can fuel your future income goal. For example, for a stock that provides a dividend yield of 5% and is growing earnings by 5% a year, resulting in a dividend-growth rate of 5%, you can approximate long-term returns of about 10% from the stock, assuming it’s trading at a fair value. According to this scenario, 10 years later, you would be sitting on a yield on cost of about 8.1%. So, for a $10,000 initial investment, you would get about $814/year in 10 years.
Dividend stock example
One stock that has a good chance of delivering income growth and long-term returns of north of 10% is Brookfield Infrastructure Partners (TSX:BIP.UN).
First, Brookfield Infrastructure Partners is in a growing industry that’s supported by trends of digitalization, decarbonization, and deglobalization. It owns and operates a diversified portfolio of quality, long-life assets across type and geography. It owns assets in transport, utility, midstream, and data infrastructure assets that are in the Americas (68% of its assets), Europe (18%), and the Asia Pacific region (14%).
Here are some of BIP’s assets. It owns predictable regulated utilities that transmit and distribute electricity and natural gas that span nine countries — Canada, the United States, India, Australia, New Zealand, Brazil, Germany, the United Kingdom, and Mexico. It also owns large rail operations in Australia, Europe, the U.K., North America, and Brazil. Its diverse range of midstream assets offer energy transmission, transportation, storage, fractionation, and value enhancement. So far, it has also expanded to having 90 data centres.
All in all, Brookfield Infrastructure targets to grow its funds from operations (FFO) per unit by north of 10% per year, which will translate to healthy cash distribution growth of 5-9% per year that targets a payout ratio of 60-70% of FFO. It targets a rate of return of 12-15% on its investments. So, it’s possible for long-term investors to get similar returns, too, especially if you buy the stock on the cheap.
At the recent price of $41.52 per unit, Brookfield Infrastructure Partners is discounted by about 19% according to the analyst consensus 12-month price target. At this quotation, it also offers a nice cash distribution yield of almost 5.3%. To be sure, the stock just raised its cash distribution by 5.9% this month, which marked its 15th consecutive year of an increase.
Let’s be conservative and assume no stock valuation expansion. Based on this yield and growth, the stock should be able to deliver long-term returns of at least 11%. BIP’s five- and 10-year cash distribution growth rates are 6.3% and 8.3%, respectively. Assuming a long-term dividend-growth rate of 6%, in 10 years, an investment today would have a yield on cost of about 9.4%.
