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Many dividend investors desire to achieve a minimum average yield across their entire portfolio of investments. For example, they want their cumulative average yield to be greater than 4%.

There is nothing wrong with this desire and investment strategy.

However, income oriented investors might be well served to instead focus on dividend growth rates and dividend cuts when evaluating initial investments and rebalancing their portfolios.

Many dividend investors focus on higher yield securities because they believe a 5% yield is better than a 1% yield. However, for long-term dividend investors it may be more important to focus on the rate at which their potential investments grow annual dividend payments.

Table 1 below highlights my previous statement. For example, suppose you have an investment initially yielding 1% that grows at 15% annually for 40 years. By the 40th year, an initial $100 investment would have paid out a total of $1,779 in dividends. By comparison, an investment initially yielding 5% and growing at 3% annually for 40 years would have paid out only $377 in dividends.

Table 1: Initial Yields, Dividend Growth Rates and Payments

Initial Yield

1.0%

2.0%

3.0%

4.0%

5.0%

Dividend Growth Rate

15.0%

12.0%

9.0%

6.0%

3.0%

Year and Yield on Cost

1

1.0%

2.0%

3.0%

4.0%

5.0%

10

3.5%

5.5%

6.5%

6.8%

6.5%

20

14.2%

17.2%

15.4%

12.1%

8.8%

30

57.6%

53.5%

36.5%

21.7%

11.8%

40

232.9%

166.2%

86.4%

38.8%

15.8%

$100 Initial Investment

1

$1.00

$2.00

$3.00

$4.00

$5.00

10

3.52

5.55

6.52

6.76

6.52

20

14.23

17.23

15.42

12.10

8.77

30

57.58

53.50

36.52

21.67

11.78

40

232.92

166.16

86.45

38.81

15.84

Total Payments

$1,779

$1,534

$1,014

$619

$377

Figure 1: Dividend Growth Rate Graph

However, it is more realistic to assume dividend growth will slow in the future. I use what I call Growth Rate Erosion (GRE) to account for this assumption of slowing growth. GRE is the initial growth rate divided by the duration of analysis. For example, if we assume an investment's initial growth rate is 12% (this is the case for the initial 2% yielding investment in Table 1) and that we are analyzing a 40-year time period, the GRE for this investment is 12% / 40, or 0.3%. Each year we multiply the number of years elapsed by the GRE and subtract the result from the initial growth rate. The implication of this for our initial 2% yielder is that in Year 1 we assume our growth rate is 12%, by Year 20 our growth rate has slowed to 6.3% and by Year 40 our growth rate is merely GRE itself, or 0.3%.

The following table uses the same initial yield and dividend growth rate assumptions in Table 1 but includes the effects of GRE.

Table 2: Initial Yields, Dividend Growth Rates and Payments With GRE

Initial Yield

1.0%

2.0%

3.0%

4.0%

5.0%

Dividend Growth Rate

15.0%

12.0%

9.0%

6.0%

3.0%

Growth Rate Erosion

0.38%

0.30%

0.23%

0.15%

0.08%

Year and Yield on Cost

1

1.0%

2.0%

3.0%

4.0%

5.0%

10

3.0%

4.9%

5.9%

6.3%

6.3%

20

7.6%

10.3%

10.4%

9.2%

7.6%

30

13.3%

16.2%

14.6%

11.6%

8.6%

40

16.3%

19.0%

16.5%

12.6%

8.9%

$100 Initial Investment

1

$1.00

$2.00

$3.00

$4.00

$5.00

10

3.03

4.91

5.93

6.34

6.31

20

7.56

10.26

10.36

9.23

7.63

30

13.29

16.16

14.60

11.61

8.56

40

16.29

19.03

16.51

12.60

8.92

Total Payments

$333

$427

$414

$360

$297

Figure 2: Yield on Cost Projection With GRE

(click to enlarge)

Using this more conservative approach inclusive of GRE to project growth rates produces interesting results. For example, our investments originally yielding 3, 4 and 5% growing at 9, 6 and 3% respectively each pays between $125 and $130 during the first 20 years of our analysis. In fact, it is not until years 20 through 40 that we see any clear leader(s) in overall dividend payments, which according to Table 2 above are the investments initially yielding 2 and 3%.

OPPORTUNITIES

For the dividend investor with a time horizon of more than 20 years (e.g. a mid-20s young professional), it may be most rewarding to find investments currently yielding between 2 and 4 percent. While investors with a shorter time horizon (e.g. a late-60s retiree) may be better served by selecting investments that presently yield between 3 and 5 percent.

Examples of companies that today yield between 2 and 5% and have a 10-year compound annual dividend growth rate greater than the ranges in my analysis above can be found below in Table 3.

Table 3: The Four Opportunities

Company Name

Symbol

Current Yield

10-Year Dividend CAGR

W.W. Grainger, Inc.

(NYSE:GWW)

1.5%

17.2%

V.F. Corporation

(NYSE:VFC)

1.9%

13.0%

Procter & Gamble Co.

(NYSE:PG)

3.1%

11.0%

Kimberly-Clark Corporation

(NYSE:KMB)

3.4%

9.0%

CONCLUSION

W.W. GRAINGER, INC.

Grainger is an all-round equipment, tools and materials distributor that was founded in 1927. Grainger not only survived the Great Depression before it was even a teenager, but also BOTH World Wars and every other hardship the World has seen in nearly the last 100 years. To top it off Grainger is a S&P 500 Dividend Aristocrat, having increased its annual dividend for 42 consecutive years.

V.F. CORPORATION

VF is a diversified apparel and footwear manufacturer owning more than 30 brands including The North Face, Nautica and Wrangler. Not only does VF sell more than 420 million items annually, it does so in more than 150 countries worldwide. Like Grainger, VF is also a S&P 500 Dividend Aristocrat.

PROCTER & GAMBLE CO.

P&G is a consumer goods manufacturer and distributor with over 70 brands, 25 of which EACH generate more than $1 billion dollars in sales annually. P&G owns household names including Pampers, Charmin and Iams. Only since 1991 has the company managed to raise its annual dividend payment by at least a whole penny, but prior to 1991 smaller increases also make P&G a S&P Dividend Aristocrat.

KIMBERLY-CLARK CORPORATION

Kimberly-Clark produces consumer goods and healthcare products worldwide. Kimberly-Clark holds the Number 1 or Number 2 brand share in more than 80 of the 175 countries it does business in. Kimberly-Clark's portfolio of brands includes Kleenex, Kotex and Huggies. Kimberly is also a S&P 500 Dividend Aristocrat, having raised its annual dividend since 1972.

Do you think any of these companies will fall by the wayside in the next 20 to 40 years, or perhaps there are even better alternative dividend growth investments? Let us know in the comments below.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: 4 Opportunities Using Dividend Growth Rate And Yield On Cost