Warren Buffett once said that: “Someone’s sitting in the shade today because someone planted a tree a long time ago.” Good for them, but I don’t want shade – I want passive income.
Fortunately, something similar is true of dividend stocks. Good ones distribute cash to shareholders for years, great ones are able to do it for generations.
Long-term returns
Since 1994, the Diageo (LSE:DGE) share price has gone from £4.60 to £25.35. That’s a 429% increase, but the real story is the income the stock generates for investors.
Over the last 12 months, the company’s paid out 82p per share in dividends. For investors who bought the stock 30 years ago, that’s an annual return of around 18%.
I’d have been too young to buy the stock back in 1994. But I have a two-year-old and I can make investments now that can generate passive income for him in the future.
The dividend yield for investors buying the stock today is 3.2%. But Diageo has increased its distributions every year for the last 37 years and I think it can keep going for a long time yet.
Risks
Diageo’s brand portfolio has leading products in several categories. On top of this, its scale is unmatched, making it extremely difficult for smaller competitors to disrupt its business.
There are however, risks for investors to consider. And the biggest is probably consumers switching to cheaper alternatives.
Over the last 30 years, wage increases haven’t been keeping pace with inflation. As a result, household budgets are under more pressure than they have been.
Despite its unmatched strength, Diageo’s brand portfolio’s firmly tilted towards the premium end of the market. This increases the risk of consumers trading down.
A Dividend Aristocrat
Despite the risks, I think Diageo can create generational passive income for investors. The company has grown its dividend through the Great Financial Crisis, Brexit, and Covid-19.
Through any 30-year period, there are challenges for businesses. But the best ones are able to keep moving forward even when things are difficult.
Diageo has done this as well as anyone. Its success hasn’t just been due to falling interest rates and low inflation – the company’s distinctive strengths have proved durable.
I think this means there’s more to come in terms of dividen growth. And with the stock at a 52-week low and the dividend yield at its highest for a decade, I’m looking to buy it.
Payout growth
The last 10 years haven’t exactly been easy for Diageo – or businesses in general. Despite the Covid-19 pandemic, the company’s increased its dividend by an average of 4.7% a year.
If this continues, the dividend per share will reach £2.93 in 2054 – a 12% return at today’s prices. And that will be something worthwhile for the next generation.
