Why dividends can help you uncover the best ASX growth stocks

In my search for ASX-listed dividend aristocrats – companies that have increased their dividend annually for 25 years or more – I discovered a unique cohort of dividend-paying, growth stocks that have outperformed the market.

These companies may not offer high yields of 4-7% typically associated with well-known dividend stocks but they have managed to consistently grow their payouts over the past 6-12 years, underpinned by strong underlying earnings growth.

Growth with dividends

The below table refers to current S&P/ASX 200 members that have increased their nominal dividends year-on-year for at least six years and their 1, 3, 5 and 10 year returns.

I have excluded the four companies (APA Group, AUB Group, Charter Hall and Soul Patts) that are tracking towards dividend aristocrat status.

Numbers at a glance

• Most dominant sectors: Tech and Financials both recorded three stocks

• Other sectors: Health Care and Materials both recorded two stocks and Real Estate, Discretionary, Telcos and Industrials all recorded one stock each

• Avg 12 month trailing dividend: 2.6%

• Highest dividend yield: IPH at 5.8%

• Lowest dividend yield: Wisetech Global at 0.13%

• Avg 1-year return: 27% (Best: Pro Medicus 117%, Worst: IPH -20%)

• Avg 3-year return: 43% (Best: Pro Medicus 166%, Worst: Sonic Healthcare -37%)

• Avg 5-year return: 128% (Best: Pro Medicus 444%, Worst: IPH -32%)

• Avg 10-year return: 2,398% (Wisetech, Netwealth and IPH have been listed for less than ten years and the average is massively inflated by Pro Medicus +16,891%, Hub24 +5,695% and Northern Star +1,007%) If you omit those three, the average is still an impressive 348%

Key Takeaways

Strategic dividend payments: Several companies including Hub24, Netwealth, Pro Medicus, Technology One and Wisetech yield less than 2% but they do so for strategic reasons:

• Attracting investors with dividend mandates – Some funds may only invest in dividend-paying companies. By paying a dividend (even if it is a tiny one), they will attract inflows from certain institutions and funds

• Because I can – These fast-growing tech companies have reached critical mass. They're profitable and able to return a small portion of profits back to shareholders while retaining the rest for growth.

• Founder-led income – Most of these companies are either founder-led or management owns millions of shares. A small dividend is one way to take money out of the business without offloading shares (e.g. Wisetech might have a 0.13% dividend yield but that still equates to approximately $19 million in dividends for CEO Richard White)

Inverse relationship: Interestingly, lower-yielding stocks like Wisetech, Technology One and Pro Medicus have shown stronger growth and outperformed higher-yielding counterparts such as Arena REIT, Brickworks, IPH and Sonic Healthcare.

Big growth: When examining the more growth-oriented companies on the list, analysts see the potential for significant dividend growth in percentage terms over the near term. Here are a few examples:

• Wisetech: Citi forecasts average annual earnings and dividend per share growth of 43.9% and 43.7% respectively over the next three years. Despite the extraordinary dividend growth, the yield will still track around 0.2-0.4%.

• Pro Medicus: Macquarie is expecting average annual earnings and dividend growth of 31% and 103% respectively over the next two years. Likewise, the dividend yield will still sit below 1.0%

There are still a few underperformers: While consistent dividend growth is often seen as a positive sign, it doesn't guarantee strong overall performance. Companies like Brickworks, Collins Foods, Sonic Healthcare, and IPH have underperformed across various time frames.

'Aristocrats' at a glance

These are the four ASX-listed companies that have managed to grow their dividends every year, for at least 14 years.

The longest winning streak currently on the ASX is held by Washington H Soul Pattinson, which is on track to deliver 24 consecutive years of ordinary dividend growth.

How do they stand?

Despite the impressive consistency, the average trailing twelve-month dividend yield is only 3.98%, largely propped up by APA Group. The other three average a yield of only 2.75%, not much higher than the 2.6% average from the growth cohort. From a share price performance perspective, they fall short on all time horizons:

• 1-year average: 9%

• 3-year average: -4%

• 5-year average: 55%

• 10-year average: 152%

Having said that, if we strip out the growth/tech companies from the above cohort (e.g. take out WTC ,TNE, PME, NWL, NST, HUB, DTL) the average returns drop to just:

• 1-year: -3.2%

• 3-year: -8.7%

• 5-year: 25.7%

• 10-year: 206.2%

Bottom line

A company's ability to pay a growing dividend can serve as a useful indicator for finding growth stocks. For a growth company, offering even a modest dividend can signal a strong balance sheet and cash flow. Importantly, these companies manage to distribute dividends while preserving capital for growth and R&D.