When looking to build a long-term portfolio of stocks that pay high dividends, investors usually come up with a mix of stocks that either have high dividend yields or high dividend growth rates. It is difficult to find good companies that have both. This means that there is often a choice to be made. All else equal, should one invest in the company that has that enticing high dividend yield, but a low dividend growth rate, or does one exhibit patience and invest in the company with a relatively low yield, but a high dividend growth rate? To help answer this question, I looked at two energy companies that offer these different alternatives: Entergy (NYSE:ETR) and Exxon (NYSE:XOM).
ETR: | |||
Div Yield | 1 Yr Div | 5 Yr Div | |
5.2% | 0% | 2.1% | |
XOM: | |||
Div Yield | 1 Yr Div | 5 Yr Div | |
2.5% | 20% | 12.6% |
There are clear differences in the two companies' dividend yields, as well as the growth rates. This presents a great case study in which company will give the investor a better return due to dividends over time. More specifically, I want to measure the Yield on Cost (YOC) and how it changes over time, as well as the compounded annual return due to dividends. The YOC simply measures the annual dividend divided by the original investment in the company's stock.
I ran the following analysis in our free calculator, called Dividend Yield And Growth. Starting with the simplified assumption that the growth rate of each dividend follows the five year growth rate, we see the following:
It takes 8 years for the YOC for Exxon to break even with the YOC for Entergy. Of course, due to compounding, we see the YOC for Exxon explode upward eventually. But this assumes that the company can continue its relatively high rate of dividend growth going forward.
Even more important than the YOC is the compounded total return over time. Even if we assume that Exxon's dividend growth rate continues at this relatively high rate, the compounded return for this stock will take 18 years to break even with Entergy. It is also important to note that I do not consider any price appreciation in these calculations, and compounded returns are due solely to dividends.
It is also important to point out that Exxon just raised its dividend by a whopping 20%. So what would the numbers look like if we boosted its annual dividend growth rate to 15% from 12.6%? I found that the compounded returns in this scenario would break even in about 14 years, with Exxon having a total compounded return of 361% over the 20 year time frame and Entergy having a compounded return of 248%.
Basically, Entergy is a fantastic investment for a retirement portfolio if it can keep its strong dividend yield of 5.4% and eek out dividend growth above 2%. Even if growth in its dividend is miniscule, the yield alone will give investors a solid return for many years. I am also a strong believer in Exxon, a company which has shown remarkably consistent dividend growth over decades.
Lastly, I have found by plugging various dividend yields into our Retirement Planner that finding dividend payers who can return just 2% more than bonds or other dividend payers can increase the time that funds last in retirement by more than a decade. The key is finding companies that will either pay a strong dividend or have serious dividend growth and have shown a culture of not cutting dividends when times get tough.
Disclosure: I am long XOM. 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.