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3 dividend growth stocks that could help you quit your job

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Many new investors — and some more experienced ones — underestimate the value of dividends. It’s not really surprising. If you invest £1,000 in a stock with a yield of 3%, a £30 dividend seems relatively insignificant compared with your capital outlay. After all, even a 10% rise in the share price would put you £100 up. However, the real value of that £30 dividend comes from the miracle effects of ‘compounding’ over time.

According to data from Schroders, if you’d invested $1,000 on 1 January 1993 in the MSCI World Index, your capital would have increased to $3,231 by 7 March 2018, representing annualised growth in your wealth of 5.9%. However, if you’d reinvested all your dividends, the same $1,000 investment in the MSCI World would have produced a return of $6,416, representing annualised growth of 8.3%. This is the miracle of compounding at work… you earn returns on your returns and these snowball over time.

Crème de la crème

Now, market indexes, such as the MSCI World or the FTSE All-Share, include companies that don’t pay dividends and many companies that will have had dividend cuts during a 25-year period, or spells of no dividend growth.

Relatively few FTSE All-Share companies have been able to increase their dividends each and every year for more than two decades. But such companies that have are highly prized by investors. Indeed, in time, they could be generating enough dividends for you to quit your job and live off the income. Of course, there’s no guarantee that these companies will continue their records in the future, but I’ve got three for you that I believe have good prospects.

Global giant

Drinks giant Diageo (LSE: DGE) is a £68bn FTSE 100 blue chip. It has a stable of highly valuable brands: Johnnie Walker whisky, Smirnoff vodka, Gordon’s gin, and many others. The group’s drinks are enjoyed by people in more than 180 countries around the world.

Well-loved brands, geographical diversification and the defensive nature of the business (alcohol consumption tends to hold up well through economic cycles) have helped Diageo deliver a history of annual dividend increases going back into the 20th century.

Sip on a dip

The company came through a lean period for earnings a few years ago but was still able to increase its dividend. The outlook for earnings growth is now much improved, with City analysts forecasting high-single-digit advances this year and next and, of course, continuing increases in the annual dividend.

The shares have made strong gains as the earnings outlook has improved. They’re trading at around 2,750p as I’m writing, compared with sub-2,000p 24 months ago. The 12-month forward price-to-earnings (P/E) ratio is 21.9 and the prospective dividend yield is 2.5%.

Now, I mentioned earlier that dividend growth stars like Diageo are highly prized by investors. As such, they tend to trade on premium P/Es and below-market-average yields. Unfortunately, Diageo’s P/E is currently towards the higher end of its historical range and its yield is towards the lower end.

I agree with my Foolish colleague Kevin Godbold that long-term investors should still do well from the stock but I think the ideal time to buy is when the yield on offer is nearer 3% (and sometimes above). Personally, I rate the stock a ‘hold’ at the current level but would see a dip in the share price — pushing the current 2.5% yield up a bit — as a good buying opportunity.

Soap not bubbling

PZ Cussons (LSE: PZC) is another company in the consumer goods industry. In addition to Cussons’ venerable Imperial Leather soap brand, it owns other personal care & beauty brands, such as Carex and St Tropez, as well as home care brands. In some of its markets it also operates in the electricals and food & nutrition segments.

While Diageo has come through a period of lean earnings, Cussons is in the midst of one. In fact, it’s forecast to post a 20% fall in earnings per share when it reports results for its financial year ended 31 May — before a return to modest growth in fiscal 2019. Its international exposure isn’t as broad as Diageo’s. Economic conditions have been tough for some years in its large Nigeria market and this has recently been compounded by headwinds in another large market, the UK, where consumers are shopping more cautiously as a result of economic uncertainty.

Dividend record at risk

In its results last year, Cussons delivered a dividend increase for the 44th consecutive year. However, the City consensus is for a 5% reduction in the payout this year. I don’t believe the company is in a position where it has to cut the dividend. Much will depend on what the board thinks is prudent and how keen it is to maintain that terrific record of annual increases.

On the positive side — and in contrast to Diageo — Cussons’ depressed share price of 225p means its 12-month forward P/E of 16.3 is towards the lower end of its historical range. Meanwhile, its prospective yield is at the higher end: 3.7% if the dividend is maintained and 3.5% if cut in line with the City consensus forecast. Despite this FTSE 250 company’s current difficulties, I believe it has excellent long-term prospects and I rate the stock a ‘buy’.

Blue-chip smaller company

Brewer and pubs company Fuller, Smith & Turner (LSE: FSTA) released results for its financial year ended 31 March earlier this month. The board said it was increasing the annual dividend by 4%, “continuing seven decades of unbroken growth.” If ever a FTSE SmallCap company could be described as a blue chip, Fullers is surely it.

Despite all the Brexit hoo-ha, I expect London to remain, as it has been for centuries, one of the most dynamic capital cities in the world. And I expect Fullers, with its London and south-east focus and well-invested estate of brilliant pubs, to thrive alongside it — as it has done since it was founded in 1845.

At a share price of 950p — down from 976p when I last looked at it — Fullers trades on a forward P/E of 14.8, which I reckon represents great value. The prospective dividend yield is only 2.2% but the payout is covered more than three times by earnings. And thinking of the miracle of compounding over seven decades, I rate the stock a ‘buy’.

Buy-And-Hold Investing

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK owns shares of PZ Cussons. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.