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Value, CFA, dividend growth investing, research analyst
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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 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 companies that offer these different alternatives: Coca-Cola (KO) and AT&T (T)

KO:   
Div Yield1 Yr Div
Growth Rate
5 Yr Div
Growth Rate
Payout Ratio
2.8%9.8%8.4%55.0%
    
T:   
Div Yield1 Yr Div
Growth Rate
5 Yr Div
Growth Rate
Payout Ratio
5.1%2.3%3.8%135.0%

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 greater 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.

The five year growth rate of dividends for Coca-Cola far exceeds that of AT&T. The one year growth rate difference is even larger. For this example I will assume that Coca-Cola's dividend grows at the five year rate of 8.4% and AT&T maintains a growth rate of 2.3%. I ran the following results in our free calculator called Dividend Yield And Growth.

It takes 11 years for the YOC for Coca-Cola to break even with the YOC for AT&T. Of course, due to compounding we see the YOC for Coca-Cola explode upward eventually. But this assumes that the company can continue its relatively high rate of dividend growth going forward.

Interestingly, although the yield on cost breaks even after nine years, the compounded returns never break even in the 20 year time frame. 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.

Many investors believe that AT&T will not be able to continue growing its dividend going forward. In fact, many expect a dividend cut. Their payout ratio is already above 100%, which means their dividend payments are above their net income. So what do the numbers look like if we assume that AT&T's dividend growth rate will be 0% over the next 20 years? Surprisingly it still takes 18 years for Coca-Cola to break even with AT&T in terms of compounded returns. This just shows that a high starting dividend yield can make up for low growth for a long period of time.

When constructing a dividend portfolio for the long-run, it is important to keep in mind just how long it might take for a lower dividend yield to catch up with a stock that pays a higher yield. That low yield stock that you think will have stellar dividend growth rates might still not be worth putting in your portfolio until the dividend yield has risen enough to make it worthwhile.

Source: Dividend Yield Vs. Dividend Growth: AT&T & Coca-Cola