How ASX growth shares can become top dividend stocks

Are growth stocks passive income power plays in the making?

Man holding Australian dollar notes, symbolising dividends.

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ASX growth shares aren't known for their dividends, but I'm going to tell you how growing businesses could become great options for passive income.

Investors may think of blue-chip names like ANZ Group Holdings Ltd (ASX: ANZ) and Rio Tinto Ltd (ASX: RIO) for income because of their high dividend yield. However, the dividends usually don't grow at a strong compound annual growth rate (CAGR).

According to Commsec, in FY24, ANZ is predicted to pay a grossed-up dividend yield of 8.4% and Rio Tinto is predicted to pay a grossed-up dividend yield of 7.5%.

I will show you how smaller, growing businesses can become very compelling picks for big dividends. However, keep in mind that not every growth stock turns into a major dividend success.

The strength of compounding

The dividends of some ASX large-cap shares have gone sideways, or even downward over the past decade. At the current share price, the 2014 payout from ANZ represents a grossed-up dividend yield of 9%. It's lower now than it was then.

There are a number of ASX growth shares that have grown their dividends substantially over the past decade, such as TechnologyOne Ltd (ASX: TNE), REA Group Limited (ASX: REA), Lovisa Holdings Ltd (ASX: LOV) and Johns Lyng Group Ltd (ASX: JLG). It's thanks to the power of their compounding.

Profits generated pay for dividends. If a business can grow its profit, then the dividend can grow too, assuming the company maintains (or increases) its dividend payout ratio.

Smaller ASX growth shares are capable of scaling their profit significantly over the long term, particularly if they expand overseas. If the dividend keeps growing at the same pace as profit, the dividend payout can eventually become impressive on that original cost base.

The TechnologyOne dividend payout per share increased by around 250% between FY13 and FY23. The FY23 payout represents a grossed-up dividend yield of around 17% compared to the TechnologyOne share price at the start of 2013.

The REA Group dividend payout per share has increased by approximately 200% comparing the last 12 months of dividends to the FY14 payout. The last two dividends from REA Group represent a grossed-up dividend yield of over 13% compared to the REA Group share price at the start of 2013.

And there has been excellent capital growth by these two stocks in that time.

Lovisa and Johns Lyng haven't been paying dividends as long as TechnologyOne and REA Group, but they already have an impressive longer-term growth history. I'm backing them for longer-term success.

Where I'd invest for long-term dividend growth

I wouldn't pick TechnologyOne and REA Group today for long-term dividends – their valuations are much higher today than a decade ago, and the profit growth rate will probably be slower because it's harder to keep growing at a fast pace the bigger a business becomes.

I'm a fan of the international growth outlooks of both Lovisa and Johns Lyng (and I'm a shareholder in both). In a decade from now, I think their payouts could be a lot bigger, particularly if they can both execute well on the US growth plans.

Other dividend payers I'd keep my eye on include Collins Foods Ltd (ASX: CKF), Corporate Travel Management Ltd (ASX: CTD) and Step One Clothing Ltd (ASX: STP).

Motley Fool contributor Tristan Harrison has positions in Collins Foods, Johns Lyng Group, and Lovisa. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Corporate Travel Management, Johns Lyng Group, Lovisa, REA Group, and Technology One. The Motley Fool Australia has positions in and has recommended Corporate Travel Management. The Motley Fool Australia has recommended Collins Foods, Johns Lyng Group, Lovisa, REA Group, and Technology One. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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