Image source: Getty Images
There are many FTSE 100 stocks with an eye-catching dividend yield. The one I’m looking at for my portfolio in May, it’s not that obvious.
The current yield is only 3.03%. But I don’t think that even remotely covers the potential opportunity available right now.
Investment of dividend
High dividend yields bring attractive return opportunities. If you invest £10,000 in stocks with a 7.5% yield, you get £750 in the first year.
Reinvesting this takes your portfolio to a total of £10,750. This, however, is not the only way for equity investors to get this kind of return.
If you invest the same £10,000 in stocks with a 2.5% yield, you get £250. But if it increases its dividend by 5%, the end result may be the same.
For the dividend yield to remain the same, the share price must rise in line with the increase. That takes the value of your investment to £10,500.
Adding in the £250 dividend results in £10,750 – a 7.5% return in the first year. That’s how a low-yielding stock can be the same as a high-yielding one.
Warren Buffett
Yes, there are al,ot of ‘ifs’ here. But in the letter of 2023 to Berkshire Hathaway shareholders, Warren Buffett explained this process well.
In 1994, Berkshire completed a $1.3bn investment Coca-Cola. In the first year, this generated $75m in dividends.
By the end of 2022, the share has increased to $704m. But – as Buffett points out – the real returns come from rising stock prices: “These gains, while exciting, are not great. But they bring significant gains to stock prices. At the end of the year, our Coke investment totaled $25bn.”
Share prices don’t automatically follow earnings – that’s not how the stock market works. But over time, they often reflect changes in the underlying business.
What is a stock?
That brings me to the stock I’m looking at in May. That’s right 3 i (LSE:III) – an FTSE 100 private company.
paid a dividend of 3.03 %. But since 2021, the company has increased its dividends per share by 107.07%.
That’s an average of 15.44% per year. So it is no coincidence that the stock has increased by almost the same amount – 102.96%.
That is an outstanding result. But it’s not a risk – it comes from the fact that 3i invests its own money, rather than raising money from investors.
That means it can buy and sell when it sees opportunities, rather than following specific timelines. This is a huge advantage and I don’t see it changing.
Risks and rewards
3i’s approach led to a portfolio focused on a European retailer called Action. And that can bring dangers.
Action’s growth has slowed down a bit this year and hence 3i’s share price has fallen. But the company’s fundamental strength is still very strong.
That’s why the stock is down 18.94% since the start of the year. And I think dividend investors should take a look.
