Imagine you're comparing two dividend investments. Investment A yields 6% today. Investment B yields just 3%. Which would you choose? If you're like most investors, you'd instinctively reach for Investment A. But what if we told you that Investment B could make you significantly wealthier over the next decade?
The difference lies in understanding one of the most powerful—yet widely misunderstood—concepts in dividend investing: dividend growth. Today, we'll show you why focusing on a stock's current yield is like judging a movie by its first scene.
The Problem with a "Static" View of Yield
Most investors fall into what we call the "yield snapshot trap." They see a dividend yield—let's say 4.2%—and assume that's what they'll earn indefinitely. This static thinking ignores the dynamic nature of successful businesses and the compounding power of dividend growth.
The Static Yield Trap
Common Mistake: Choosing investments based solely on current dividend yield, ignoring the trajectory of future dividend payments.
Consider these two scenarios over a 10-year period:
High-Yield, No Growth
Lower Yield, 7% Growth
At first glance, the high-yield stock appears superior. But this analysis misses the most important part of the story: what happens to the stock price when investors realize that one company is growing its cash flows while the other isn't.
The Critical Question
A static 6% yield often signals a business in decline. A growing 3% yield usually indicates a thriving enterprise. Which would you rather own for the next decade?
Introducing "Yield on Cost": Your Personal Pay Rise
Here's where dividend growth investing becomes truly powerful. "Yield on cost" measures your dividend yield based on your original purchase price, not the current stock price. As companies grow their dividends, your personal yield increases year after year.
A Real-World Example: The Power of Time
Let's follow a hypothetical €10,000 investment in a quality dividend growth company:
| Year | Annual Dividend | Yield on Cost | Cumulative Income |
|---|---|---|---|
| Year 1 | €300 | 3.0% | €300 |
| Year 3 | €347 | 3.5% | €947 |
| Year 5 | €402 | 4.0% | €1,734 |
| Year 7 | €466 | 4.7% | €2,656 |
| Year 10 | €590 | 5.9% | €4,142 |
By Year 10, your "yield on cost" has nearly doubled from 3.0% to 5.9%. But here's the remarkable part: this is just the beginning.
The 20-Year Picture
If this 7% dividend growth continues for 20 years, your yield on cost reaches an extraordinary 11.6%. You're now earning more than €1,160 annually in dividends from your original €10,000 investment—plus you still own the appreciating stock.
*Hypothetical example assuming consistent 7% annual dividend growth for illustration purposes only. Actual dividend growth rates vary widely and may be higher, lower, or negative in any given period. Past performance does not guarantee future results. All investments carry risk of loss.
This is why experienced dividend investors often talk about "planting trees." The modest yields you plant today grow into substantial income streams that can support you for decades.
The Link Between Dividend Growth and Company Quality
Not every company can consistently grow its dividend by 7% annually. In fact, very few can. Sustained dividend growth requires something special: a high-quality business with durable competitive advantages.
The Quality Connection
Companies that can raise dividends year after year possess strong competitive moats, pricing power, and efficient capital allocation—the hallmarks of exceptional businesses.
What Enables Consistent Dividend Growth?
Growing Earnings
Companies must consistently increase profits to fund higher dividend payments.
Strong Cash Flow
Reliable cash generation provides the foundation for sustainable dividend growth.
Competitive Advantages
Durable moats protect market share and pricing power.
Conservative Debt Levels
Moderate leverage ensures financial flexibility during economic downturns.
Shareholder-Friendly Management
Leadership committed to returning capital to shareholders through dividends.
Reinvestment Opportunities
Ability to profitably reinvest capital to drive future growth.
This is why our quality screening process, discussed in our previous article, focuses on these fundamental business characteristics. We're not just looking for dividend payers—we're identifying the rare companies capable of growing those dividends year after year.
The Meridian Standard
Every company in our portfolio must demonstrate not just the ability to pay dividends today, but the capacity to increase them tomorrow. This dual requirement—current income and future growth—separates truly exceptional businesses from the merely adequate.
The Power of Compounding: Total Return is King
Dividend growth investing provides two powerful engines of return working in harmony: growing income and capital appreciation. As companies increase their dividend payments, their stock prices typically rise to reflect their improved cash flow generation.
The Dual Return Engine
Growing Income Stream
Your dividend payments increase annually, providing inflation protection and growing purchasing power over time.
Capital Appreciation
As earnings and dividends grow, stock prices typically follow, providing capital gains on top of dividend income.
The Evidence Supporting Dividend Growth
Academic research and market analysis consistently demonstrate that companies with strong dividend growth characteristics tend to exhibit superior long-term performance. The key insight is not about chasing the highest returns, but about understanding the business quality that enables sustainable dividend growth.
Key Research Findings
Dividend Aristocrats Study: Companies in the S&P 500 that have increased dividends for 25+ consecutive years have historically outperformed the broader index over multiple time periods.
Quality Factor Research: Academic studies show that high-quality companies (measured by profitability, balance sheet strength, and earnings stability) tend to generate superior risk-adjusted returns.
Compound Growth Analysis: Mathematical compounding demonstrates how modest dividend growth rates can significantly outperform static high yields over extended periods.
Hypothetical Compound Growth Illustration
To illustrate the power of compounding: a €100,000 investment growing at 8% annually would reach approximately €466,000 after 20 years. The same investment at 10% would reach €673,000. This demonstrates why even small improvements in investment quality can have profound long-term effects.
*Hypothetical illustration for educational purposes only. Does not represent any specific investment or guarantee future results. All investments carry risk of loss.
This is the true power of dividend growth investing: you're not choosing between income and growth—you're getting both, compounding together over time to create superior long-term wealth accumulation.
The Message is Clear: Don't Just Look at Our Starting Yield
When evaluating Meridian Global Investors' funds, resist the temptation to focus solely on today's dividend yield. Instead, consider our potential for growth.
Every company in our portfolio has been selected not just for its current dividend, but for its demonstrated ability to grow that dividend over time. We're building portfolios designed to provide increasing income streams that can outpace inflation and support your long-term financial goals.
A modestly yielding investment with consistent dividend growth may eventually outperform a higher static yield over extended periods—illustrating why dividend growth potential matters more than starting yield alone.
Key Takeaways for Long-Term Investors
Think Beyond Today's Yield
Focus on yield-on-cost potential rather than current dividend yield.
Quality Enables Growth
Only high-quality companies can sustain long-term dividend growth.
Time is Your Ally
The longer you hold dividend growth stocks, the more powerful the compounding becomes.
Total Return Mindset
Combine growing income with capital appreciation for superior results.
Inflation Protection
Growing dividends help maintain purchasing power over decades.
Patience Pays
The best dividend growth strategies require long-term commitment to maximize returns.