Are you seeking the best dividend yields of 2016? That’s 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 that’s 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 I’m mad, but please bear with me.
There are two important things here. Firstly, the 0.7% yield that’s 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 ARM’s 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 ARM’s dividends have been rising way above inflation since the company first started paying them in 2003.
Looking back a decade, in 2005 ARM’s 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, you’d have had a yield of just 0.7% — but if you’d bought the shares and held them, you’d 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 that’s kept the annual dividend yield at less than 1% — but you shouldn’t let that hide the remarkable dividend rises and the massive effective yield that last decade’s investors are enjoying today.
The next decade?
So what of the future? Well, if ARM’s dividend keeps on growing by 20% a year, we’d be looking at around 21p per share by 2020, and on today’s share price, that would provide an effective yield of 2% — not massive, but still 2.5 times better than this year. And in another decade’s time, 2025’s dividend would have grown to a very impressive 51p per share, providing a yield of 4.9% on today’s 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, they’ll be pocketing a dividend yield of 41% on their original purchase price!
From growth to maturity
Of course, ARM’s earnings growth must eventually start to slow, although I can’t 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 shouldn’t be blinded by today’s 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.
