Telecommunication stocks have enticed many investors recently with their relatively high dividend yields. Sometimes it's easy to be sucked into a company because its dividend yield is so strong. But it's very important not to overlook the most recent growth rate of the dividend and projected future growth rates. As an example of this, I want to compare two t-com stocks with relatively high yields: AT&T (NYSE:T) and Century Link (NYSE:CTL).
We can see right away that neither company is knocking it out of the park when it comes to growing their dividends recently. This is not surprising given that Century Link has a debt to equity ratio of 103% and a payout ratio of 284%, while AT&T has debt to equity of 75% and a payout ratio of 141%.
With such high payout ratios, which is simply the percent of net income that goes to shareholders, it is very doubtful we will see high dividend growth rates from either company any time soon. So for the sake of comparison, let's see how these two stocks will fare if we assume they will continue to grow dividends at their one year growth rate. 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 over20 years:
It takes 12 years for the YOC for AT&T to break even with the YOC for Century Link. However, even more important than the YOC is the compounded total return over time. We can see that AT&T's compounded return simply never breaks even with Century Link's. AT&T's dividend growth is just not high enough. 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.
What if we assume that AT&T will double its dividend growth rate? In this case the compounded returns will break even in about 13 years and the overall total return for AT&T over 20 years will be 318%, while the overall return for Century Link would be 287%.
It is clear from this exercise that looking at dividend yield is not enough. One must have some type of forecast for dividend growth going forward, otherwise it is impossible to make a sound decision on which dividend-paying stocks to buy.