Published: September 20, 2010

As income investors, we can get caught up in yields... almost to a fault. But there is something else you should be studying that could make just as big a difference to your long-term returns: dividend growth.

That's because dividend growth can make even lower-yielding stocks into big income producers over time. Take a look below at the income streams from a stock yielding 7% but not growing dividends, versus a 5% yielder that hikes payments +10% every year. If you held 1,000 shares trading at a $10 share price, here is the income stream each would produce over a year:
 

In just five years, that 5% yield would actually be worth more than the 7% yield. And just two years later, your income stream would grow to be +27% more than the stock yielding 7%! Keep in mind, this doesn't take into account rising share prices. If both yields stayed the same, the share price of the 5% yielder would have to grow to $17.72 -- a +77% gain.

Buying stocks that increase dividends allows you to take advantage of one of the most powerful tools in the investors’ arsenal -- the wealth-building effect of compounding. And consistent dividend growth is like jet fuel for the compounding engine.
 

But there are more advantages to companies able to consistently grow dividend payments. One often overlooked "plus" is that they tend to be safer investments. Dividends are a litmus test of a company’s true financial strength. Only companies able to grow earnings through good times and bad will commit to consistently raising dividends. And these are the types of business that tend to see more stability in their shares.

The best measure of their value is how dividend growers perform over time. And the best proof lies in a special index created by Standard & Poor’s, called the “Dividend Aristocrats.” Every company on this list must that have posted increased dividends in each of the past 25 years.

According to S&P data, the Dividend Aristocrats have consistently outperformed the broader S&P 500. Dividend Aristocrats fell only -22% during the 2008 market crash, much less than the -37% decline for the S&P 500. Moreover, the group rebounded +27% the following year, slightly better than the +26% gain on the S&P 500.

As you would guess, the ranks of Dividend Aristocrats are exclusive -- only 42 of the 500 companies in the S&P made the list this year (about 8% of the index). I used this list of 42 companies as my starting point and then looked at nine companies that were raising payments the fastest:
 

Pitney Bowes (NYSE: PBI)
Yield: 7.0%
Pitney Bowes yields 7.0% and has recorded 28 consecutive years of dividend growth. Its business is boring -- it makes postage meters and mail processing equipment, but its dividend growth is anything but. Dividends have grown +10% a year since Pitney Bowes began paying investors in 1982. The 2010 increase of about +1.5% was a below average, but it did raise the annual payment to $1.46 per share.

Eli Lilly (NYSE: LLY)
Yield: 5.5%
Healthcare is less impacted by recession than other sectors, so it’s no surprise to find multiple healthcare companies on the list of dividend growers. Eli Lilly is a leading global drug maker and has an uninterrupted record of roughly 40 years of dividend growth. In the last decade, Lilly has grown its dividend +8% a year. The company last increased the dividend by +3% to a $1.96 annual payment in 2009, meaning a dividend increase is likely in the next quarter if Eli Lilly wants to maintain its track record.

Cincinnati Financial Corp (Nasdaq: CINF)
Yield: 5.4%
The only financial company that made the list above is property/casualty insurance provider, Cincinnati Financial. This company has raised dividends 49 years in a row, setting the stage for a wonderful half-century of increasing payments. Dividend increases of late have slowed in line with the overall economic outlook, but consider that in 1999 the company paid just about $0.60 a share, compared to today's $1.60 annual rate.

Leggett & Platt (NYSE: LEG)
Yield: 5.0%
Fixture and furniture manufacturer Leggett & Platt is seeing a rebound in its markets and signaled confidence in its future prospects in August by hiking the dividend +4% to a $1.08 per share annual rate. The company now boasts an impressive track record of 39 years of dividend growth.

Johnson & Johnson (NYSE: JNJ)
Yield: 3.5%
Johnson & Johnson's 3.7% yield isn't likely to "wow" you -- but remember the example above when it comes to growing dividend payments. The company has increased dividends 48 years in a row. The last increase, announced in April, boosted the dividend by +10% to a $2.16 annual rate.

Abbott Labs (NYSE: ABT)
Yield: 3.4%
Drug manufacturer Abbott Labs has grown dividends for 38 years running. Like Johnson & Johnson, it's another medical company that doesn't pay a high "headline" yield, but it can grow payments. In the past decade, dividend growth has averaged nearly +9% a year. The last hike, announced in February, was a +10% increase. Abbot now pays a $1.76 annual dividend, up from just $0.74 in 2000.

Automatic Data Processing (Nasdaq: ADP)
Yield: 3.3%
Automatic Data Processing provides payroll processing services to thousands of businesses nationwide. Even with unemployment now at a high, this company has been able to hike dividends every year for 35 years straight. The last increase raised the payment by +3% to a $1.36 annual rate. In the past decade, annual dividend growth has been an impressive +15%.

McGraw-Hill (NYSE: MHP)
Yield: 3.1%
You might not know it, but McGraw-Hill actually owns Standard & Poor’s, so it is only fitting this company makes S&P's Dividend Aristocrats list. McGraw-Hill's ranking comes thanks to 37 straight years of dividend growth. In the last decade, dividends have grown +7% a year. This includes the last dividend hike, announced in January, to a $0.94 annual rate.

PPG Industries (NYSE: PPG)
Yield: 3.1%
PPG Industries is a new member to the list, with "only" 25 years of dividend increases -- but it has paid 448 consecutive dividends. This maker of sealants and window coatings also stands out as the only Dividend Aristocrat to raise dividends twice in the past year. The last hike in July was by a penny per quarter to a $2.20 annual rate.

Action to Take --> Before investing in any of the ideas above, I would want to examine each in more detail, considering factors like business outlook and financial strength. Still, the combination of dividend increases and a solid yield makes this list an interesting starting point for further research.

-- Carla Pasternak
Editor
High-Yield Investing, High-Yield International