Why Your Portfolio's Long-Term Dividend Growth Rate Is Your Total Return

Includes: BDX, KO, PM, XOM
by: Ry The Kid

I have been reading Seeking Alpha for over a year and decided it was time to write my first article. Many pieces have been written on dividends vs. total return, but here is a look at them from a different point of view. Before I begin, let me just say that I am a dividend growth investor. All the charts and graphs in the world will never sway me from this, and additionally I will only own stocks that pay a rising dividend. However, just because I am only a dividend growth investor that doesn't mean that I cast aside total returns. Because I am a dividend growth investor, I have to be a total return investor. Let me show you how I came to this revelation.

I was reading the first article by Integrator, and I wanted to look at dividend growth rates in a new light. If an investor can pick a stock that is highly likely to continue to raise it's dividend at a decent annual clip of, say 12%, then most likely your return in 20 years will be equal or greater than 12%. Exxon Mobil (NYSE:XOM) currently trades around $90 and pays $.57/quarter in dividends, now if they were to raise it 12% a year for 2 decades it would be $5.50/quarter. If the share price stagnated for 20 years, it's yield would be about 25% based on share price of $90. Obviously we know the yield will never get that high because we would all mortgage our homes and then some to get XOM at 25%. Hell, most of us would be delighted to pick up shares of XOM at above 3% yield.

The point I am trying to make is that as XOM raises it's payout year in and year out, the price will most likely raise by the same amount or more, long-term. You will never be able to buy XOM at $33 a share anymore, while it's paying out $2.28 yearly, because even during a downturn it's dividend yield will increase to the point where investors begin to buy for the dividend yield, bringing the yield back to it's equilibrium. However, 10 years ago, you could have bought it for $33, when it was only paying out $1 a yearly in dividends, putting its yield at under 3%, just where it sits today. The same rule applies without a downturn, as the yield goes up, and payouts increase, people will continue to buy shares and bring the yield back down to it's traditional equilibrium.

Now here's the kicker for you total return investors that cast aside dividends; dividend growth HAS to lead a capital gains, because the yield will be kept below a certain level because as it rises it becomes more enticing to contrarian investors. This is the reason why dividends are so important. When the dividend payout increases, but the yield stays the same, you win. That means that investors bought enough shares to bring the yield back to it's norm. That's capital gains baby. As an investor in accumulation stage, I can only hope that share prices tank while payouts increase, but this doesn't happen too often with high quality companies outside of a market correction. If your argument is to the contrary because you've owned stocks that had growing dividends and you still lost money, it's because you either picked a poor company or poor time to sell.

To "prove" my theory: This is exactly what Becton, Dickinson & Co (NYSE:BDX) has done over the last 15 years. In 1997 BDX traded at about $13, now it's $94. Up about 650% (excluding dividends) or about 14% per year, now let's see what happened to the dividends during that time. In 1997 BDX paid dividends of $0.07/quarter and now it's paying out $0.50/quarter, up about 700% or about 14% per year. In those 15 years we went through multiple wars and recessions but at the end of the day the share price still increased at just about the same pace the dividends were increased. There was never a time you could own BDX at $20, with a $2/year dividend, because as the dividend increased, so did the share price. This is another reason why dividend growth is so important. I will even go so far as to say that dividend growth is one of the most important share price boosters a company can have.

In conclusion, I believe that if you pick a wonderful company and hold on to it for decades, your total returns should mirror (for better or worse) what the dividend increases have been over that period of time. I'm hoping that Philip Morris International (NYSE:PM) will continue to raise their dividend at an above average clip, and that my total return mirrors the dividend growth rate. I can only hope that all the companies I own will increase their payouts at a rate of 10% or higher for decades, which is why the dividend, and more importantly, the growth rate is a make-or-break for me in purchasing a stock. I also believe in reinvesting dividends, no matter what.

Imagine what Warren Buffett's net worth would be if he reinvested all his dividends from Coca-Cola (NYSE:KO) for the last 25 years instead of collecting them to distribute elsewhere. A sustainable, above-average dividend growth rate coupled with reinvested dividends is a proven formula for accumulating, and perhaps more importantly, maintaining, wealth.

Disclosure: I am long PM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.