Technology stocks are somewhat notorious for paying low dividends or no dividends at all. But more and more famous tech companies have matured, seen their opportunities for growth decline, and have wisely decided to pay out more of their earnings in the form of dividends.
We investors now have some wonderful choices when it comes to solid tech companies paying a dividend that has grown every year, even in recessions. However, some of these companies have a relatively large dividend yield while others have a lower yield, but a high dividend growth rate.
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 exude 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 tech companies that offer these different alternatives: Intel (INTC) and Microsoft (MSFT).
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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 one year growth rate, we see the following:
It takes only 4 years for the YOC for Microsoft to break even with the YOC for Intel. Of course, due to compounding we see the YOC for Microsoft 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 Microsoft's dividend growth rate continues at this relatively high rate, the compounded return for this stock will take 8 years to break even with Intel. 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, which are assumed to be reinvested.
Oftentimes I get the response that it isn't a fair analysis to not include any price appreciation since the price will rise with the increasing dividends. But Microsoft proves this is definitely not always the case. Since 2003 their dividends have grown by 188%, yet their stock price has only risen by 17%. Therefore, I would much rather focus on forecasting dividends than forecasting any changes in stock prices.
It is also 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.
Lastly, I have found by plugging in 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 who will either pay a strong dividend or have serious dividend growth and have shown a culture of not cutting dividends when times get tough.