Both Wal-Mart (NYSE:WMT) and Target (NYSE:TGT) have seen large increases in their stock prices over the past two years. This is good news for investors who already owned these stocks. But this is not good news for dividend growth investors who haven't purchased these stocks yet and are looking to lock in a decent dividend yield and then watch that dividend grow over time.
Even with the run-up in their stock prices, a case can be made that these companies still offer good value for dividend growth investors looking at the long run. Both companies have been increasing their dividends at a solid clip, which means that their relatively low dividend yields can be deceiving.
Let's take a look at these two companies:
Although Target's dividend yield is lower than Wal-Mart's, its dividend growth has been very impressive. Over the past five years it has increased the dividend by nearly 21% per year. 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. I assumed that there is simply no way Target can keep increasing the dividend by 20% over the long-run so I assumed a 15% rate of dividend growth for the company. For Wal-Mart I assumed the one-year dividend growth rate of 8.9% would continue. With these assumptions we see the following:
It takes only three years for the YOC for Target to break even with the YOC for Wal-Mart. Of course, due to compounding we see the YOC for Target 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 Target's dividend growth rate continues at this relatively high rate, the compounded return for this stock will take eight years to break even with Wal-Mart. It is also important to note that I assume no price appreciation for these stocks in the calculations and compounded returns are due solely to dividends, which are assumed to be reinvested.
It is also interesting to look at what growth rate of Target's dividend will cause its compounded return to break even to Wal-Mart's over a 20-year period. I ran this analysis and found the answer to be 11%. So if Target's long-run dividend growth rate is just 2% higher than Wal-Mart's, this offsets the lower starting dividend yield over the 20-year time frame.
Lastly, I have found by plugging in various dividend yields into our Retirement Planner that finding dividend payers that 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.