3 Dividend Stocks With Major Growth Potential

By Daniel SparksMarketsFool.com

For investors looking for income from their stocks, it makes sense to own some companies with robust dividend yields. But as any seasoned income investor knows, dividend yield isn't everything. Sometimes a lower dividend yield makes sense if the dividend looks poised to grow nicely over the long haul. Starbucks (NASDAQ: SBUX), Nike (NYSE: NKE), and Costco (NASDAQ: COST) are all great examples of companies with fairly small dividends positioned to grow into fat cash streams in the future.

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Here's a look at what makes these dividend stocks compelling.


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Data source: Reuters.

Starbucks offers the highest dividend yield of these three stocks, with annual dividend payments amounting to about 1.8% of the current stock price. But this is still below the average dividend yield of stocks in the S&P 500 of about 2.2%.

The coffee giant's lower-than-average dividend yield, however, can be easily forgiven once investors take a look at the dividend's growth prospects. Starbucks' dividend growth potential is evident in the company's average annual dividend increase of 24.9% during the past five years -- a trajectory clearly suggesting dividend growth is a priority for management.

And Starbucks' dividend growth potential looks even better when investors consider that the company is currently only paying out 31.3% of earnings in dividends, leaving plenty of room for more dividend hikes in the future.


Data source: Reuters.

Nike's dividend yield of 1.3% is well below the 2.2% average for the S&P 500 and even meaningfully lower than Starbucks' 1.8% yield. But the dividend's growth prospects look solid.

Not only has Nike increased its dividend at an average rate of 16.4% during the past five years, but the company is only paying out 22.4% of its earnings in dividends. Further, Nike's ability to consistently grow earnings should make future dividend increases a breeze. Nike's trailing-12-month EPS is up 11.9% from the year-ago period and the key metric has increased at an average rate of 14% annually over the past five years. If Nike can continue to grow its EPS amply this will enable more dividend increases in years to come without requiring a rapid increase in the company's payout ratio.


Data source: Reuters.

With a dividend yield of just 1.2%, dividend investors may be tempted to overlook Costco. But a closer look at the company suggests this dividend stock may be worth adding to your portfolio.

Between strong dividend growth at a compound average rate of 13.8% during the past five years and a conservative payout ratio of 32.2%, Costco's dividend looks poised for more growth in the years to come.

Sure, Costco's 5-year dividend growth is lower than Starbucks' and Nike's, but the company's unprecedented scale for its warehouse club retail model, which enables the company to simultaneously offer low prices and superior value, gives the company a significant competitive advantage over peers. This "wide moat," as famed investor Warren Buffett might call it, makes the dividend -- and the overall stock -- a low-risk bet for the long haul.

For some final perspective on why buying dividend stocks like Starbucks, Nike, and Costco makes sense despite their lower dividend yields today, consider a theoretical scenario in which each of these company's dividends increased 10% annually for the foreseeable future. This forecast, which is arguably realistic for all three of these companies, would double their dividend payments in just under seven and a half years.

Sometimes it makes sense to forego a heady dividend yield today in exchange for higher dividend yields down road.

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Daniel Sparks has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale, Nike, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.