There are a lot of FTSE 100 stocks with eye-catching dividend yields. The one I’m looking at for my portfolio in May, however, is much less conspicuous.
The current yield is only 3.03%. But I don’t think that even remotely covers the potential opportunity on offer right now.
Dividend investing
High dividend yields bring attractive reinvestment opportunities. If you invest £10,000 in a stock with a 7.5% yield, you get £750 in the first year.
Reinvesting this takes your portfolio to a total of £10,750. This, however, isn’t the only way for dividend investors to achieve this kind of return.
If you invest the same £10,000 in a stock with a 2.5% yield, you get £250. But if it raises its dividend by 5%, the end result might be the same.
For the dividend yield to stay the same, the share price has to go up in line with the increase. That takes the value of your investment to £10,500.
Adding in the £250 dividend results in £10,750 – a 7.5% return in the first year. That’s how a stock with a lower yield can match a higher one.
Warren Buffett
Yes, there are a l,ot of ‘ifs’ here. But in the 2023 letter to Berkshire Hathaway shareholders, Warren Buffett described exactly this process.
In 1994, Berkshire completed a $1.3bn investment in Coca-Cola. In the first year, this generated $75m in dividends.
By the end of 2022, the dividend had increased to $704m. But – as Buffett pointed out – the real return came from the rising share price: “These dividend gains, though pleasing, are far from spectacular. But they bring with them important gains in stock prices. At year-end, our Coke investment was valued at $25bn.”
Share prices don’t automatically follow dividends of course – that’s not how the stock market works. But over time, they tend to reflect changes in the underlying business.
What’s the stock?
That brings me to the stock I’ve got my eye on in May. It’s 3i (LSE:III) – a FTSE 100 private equity firm.
A 3.03% dividend yield isn’t particularly exciting. But since 2021, the company has increased its dividend per share by 107.07%.
That’s an average of 15.44% a year. It’s therefore no coincidence that the stock is up by almost the same amount – 102.96%.
Source: FIscal.ai
That’s an outstanding result. But it’s not an accident – it comes from the fact that 3i invests its own capital, rather than raising cash from investors.
That means it can buy and sell when it sees opportunities, rather than on specific timelines. This is a huge advantage and I don’t see it changing.
Risks and rewards
3i’s approach has resulted in a portfolio that’s heavily concentrated in a European retailer called Action. And that can bring risks.
Action’s growth has faltered a bit this year and that’s why 3i’s share price is down. But the firm’s core strength is still very much intact.
That’s why the stock falling 18.94% since the start of the year is catching my attention. And I think dividend investors should take a look.
