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mIf you're looking to generate income from your investments, focusing solely on securities or funds with high current interest or dividend payouts may offer a quick solution. However, a long-term strategy centered on increasing dividend income could yield better results over time.

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Investors seeking exposure to companies with a consistent history of dividend growth have many options, including mutual funds and exchange-traded funds that focus on such stocks. Yet, some prefer direct investments in individual companies.

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Previously, an analysis of the S&P 500 highlighted the advantages of dividend compounders over stocks with high dividend yields. That study showed that stocks with the highest dividend yields five years ago often underperformed the index. A high yield can sometimes indicate a declining stock price, reflecting investor concerns about the company’s ability to sustain its dividend payouts. Conversely, stocks that started with moderate dividend yields but consistently increased their payouts tended to outperform the broader market.

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In that prior screen of the S&P 500, the companies with the highest compound annual growth rate (CAGR) for dividends—excluding special dividends—were identified. Goldman Sachs Group Inc. led the list, boasting a dividend CAGR of 28.01%.

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Now, a similar analysis has been conducted on smaller companies, which tend to receive less coverage than S&P 500 firms. The results show that several of these smaller firms have even higher dividend CAGRs than the leaders in the S&P 500.

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Take Owens Corning as an example. If an investor had bought shares on February 10, 2020, at a price of $61.67 per share, the company's quarterly dividend at the time was $0.24 per share, resulting in an annual payout of $0.96 and a yield of 1.56%. Holding the stock for five years would have led to a significant increase in dividend payouts, with the quarterly dividend rising to $0.69 per share, pushing the annual payout to $2.76. This translates to a five-year dividend CAGR of 23.52%, far outpacing the S&P 500’s estimated five-year dividend CAGR of 4.84%.

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In comparison, the S&P Small Cap 600 Index and the S&P MidCap 400 Index recorded five-year dividend CAGRs of 2.42% and 5.91%, respectively. While a new investor purchasing Owens Corning stock at $180.14 per share would see a current yield of only 1.53%, an investor who held the stock for five years would now enjoy a yield of 4.48% based on their initial purchase price. Additionally, the stock price nearly tripled over this period, leading to a five-year total return of 216%—far surpassing the returns of the S&P 500 (96%), the S&P Small Cap 600 Index (54%), and the S&P MidCap 400 Index (68%).

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Screening Small-Cap and Midcap Dividend Compounders

To identify other strong dividend compounders among smaller companies, the analysis began with the S&P Small Cap 600 and S&P MidCap 400 indices. Initially, 389 companies with dividend yields of at least 1.5% as of February 10, 2020, were selected. This list was further refined by examining their dividend histories over the past six years, removing any companies that had reduced their dividends in the past five years. This left 245 companies.

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Among these, 20 stood out for having the highest dividend CAGRs over the past five years. Several of these companies delivered impressive total returns, outpacing the broader market indices.

For example:

• Dick’s Sporting Goods Inc. achieved a five-year dividend CAGR of 31.95% and a total return of 535%, with its stock price surging 441%.
• First BanCorp saw a dividend CAGR of 29.20%, translating to a total return of 164%.
• Virtus Investment Partners Inc. recorded a dividend CAGR of 27.42%, delivering a total return of 55%.
• Nexstar Media Group Inc. had a CAGR of 27.13% and a total return of 41%.
• Owens Corning featured a dividend CAGR of 23.52% and a five-year total return of 216%.

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Among the 20 companies with the highest five-year dividend growth, 13 outperformed the S&P 500’s total return of 96% over the period, while 17 outperformed the S&P Small Cap 600 Index and 15 exceeded the S&P MidCap 400 Index.

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These findings reinforce the benefits of focusing on dividend compounders rather than simply chasing high-yield stocks. While some high-yield stocks may face sustainability issues, those with steadily growing payouts can provide investors with increasing income and strong overall returns over time.

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