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During the roughly six months that I've been reading about and researching investment ideas here on Seeking Alpha, one of the most commonly mentioned and discussed tenets of dividend growth investing has been the "Chowder Rule".

As described by Chowder himself, here is an explanation the famous rule:

I decided that as a dividend growth investor, I wanted the dividend and the dividend growth to take pressure off of the share price in the total return equation. I can control the dividend I take on, and I can control the companies I add via dividend growth. I have no control over share price. So, it made sense to me to focus on what I could control.

Since 8% is my total return number, I wanted to buy companies that when you combined the current yield with the 5 year compounded annual growth rate (OTCPK:CAGR), I wanted it to equal 12% or more, giving me a buffer or dividend moat against my total return objective.

In other words, if the yield is 3% I want a 5 year CAGR of 9%. If the yield is 4%, I want a 5 year CAGR of 8%. This is of course after all other fundamental criteria has been satisfied.

This investing theme is very simple in theory, yet effective in practice. Simply find high quality companies that have a long history of increasing dividends, buy them at an attractive price, and watch as your income continues to grow year after year.

In this article I would like to further examine this rule with some spreadsheets showing how the rule applies to both low yield, high growth companies as well as higher yield, slower growth companies and comparing the results over a 20 year period.

Scenario One

In the first scenario I will examine the varying initial yields from 1-6% and corresponding dividend growth rates of 6-11%, with all scenarios providing Chowder's recommended minimum number of 12. In this example I will assume that the stock price increases at the same rate as the dividend growth rate of the company (as dividends are paid out of earnings and stock prices for companies generally follow the earnings made by companies). All dividends received will immediately be reinvested into new shares, allowing the full compounding effect to occur over the 20 year period.

1% Initial Yield with 11% Annual Dividend & Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 0.501.00%$ 1,000
End 5 Years20.9584$ 84.25$ 0.841.00%$ 1,766
End 10 Years21.9628$ 141.97$ 1.421.00%$ 3,118
End 15 Years23.0152$ 239.23$ 2.391.00%$ 5,506
End 20 Years24.1181$ 403.12$ 4.041.00%$ 9,722
Total Return 20 YR CAGR:12.04%
Total Dividends Received:$ 727
Forward Annual Income:$ 97
2% Initial Yield with 10% Annual Dividend & Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 1.002.00%$ 1,000
End 5 Years21.9718$ 80.53$ 1.612.00%$ 1,769
End 10 Years24.1381$ 129.69$ 2.592.00%$ 3,130
End 15 Years26.5179$ 208.86$ 4.182.00%$ 5,539
End 20 Years29.1323$ 336.37$ 6.732.00%$ 9,799
Total Return 20 YR CAGR:12.09%
Total Dividends Received:$ 1,466
Forward Annual Income:$ 196
3% Initial Yield with 9% Annual Dividend & Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 1.503.00%$ 1,000
End 5 Years23.044$ 76.93$ 2.313.00%$ 1,773
End 10 Years26.5513$ 118.37$ 3.553.00%$ 3,143
End 15 Years30.5923$ 182.12$ 5.463.00%$ 5,571
End 20 Years35.2485$ 280.22$ 8.413.00%$ 9,877
Total Return 20 YR CAGR:12.13%
Total Dividends Received:$ 2,219
Forward Annual Income:$ 296
4% Initial Yield with 8% Annual Dividend & Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 2.004.00%$ 1,000
End 5 Years24.1789$ 73.47$ 2.944.00%$ 1,776
End 10 Years29.231$ 107.95$ 4.324.00%$ 3,155
End 15 Years35.3386$ 158.61$ 6.344.00%$ 5,605
End 20 Years42.7225$ 233.05$ 9.324.00%$ 9,956
Total Return 20 YR CAGR:12.18%
Total Dividends Received:$ 2,985
Forward Annual Income:$ 398
5% Initial Yield with 7% Annual Dividend & Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 2.505.00%$ 1,000
End 5 Years25.3809$ 70.13$ 3.515.00%$ 1,780
End 10 Years32.2096$ 98.36$ 4.925.00%$ 3,168
End 15 Years40.8755$ 137.95$ 6.905.00%$ 5,639
End 20 Years51.8729$ 193.48$ 9.675.00%$ 10,036
Total Return 20 YR CAGR:12.22%
Total Dividends Received:$ 3,765
Forward Annual Income:$ 502
6% Initial Yield with 6% Annual Dividend & Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 3.006.00%$ 1,000
End 5 Years26.6548$ 66.91$ 4.016.00%$ 1,783
End 10 Years35.5239$ 89.54$ 5.376.00%$ 3,181
End 15 Years47.3441$ 119.83$ 7.196.00%$ 5,673
End 20 Years63.0973$ 160.36$ 9.626.00%$ 10,118
Total Return 20 YR CAGR:12.27%
Total Dividends Received:$ 4,558
Forward Annual Income:$ 607

As you can see in the first scenario, the total value of the six portfolios after 20 years is remarkably similar. The low yield, high growth stocks had much lower dividends paid but also had higher share prices than the slower growers. So while income generated from the portfolios varied from $727 to $4,558, a difference of 527%, the final value of the portfolios only varied from $9,722 to $10,118 or a difference of just over 4%.

Since the portfolio values are all pretty much the same at the end of the period, the forward dividend income is a direct relationship to the difference of the yield for each portfolio, causing income to range from roughly $100 to $600.

Scenario Two

In the second scenario I will examine the same initial yields and dividend growth rates as used in scenario one, but rather than having the share price appreciate in lock step with the dividend growth rate, we will assume a share price that grows at half the dividend growth rate over the course of the 20 year period.

1% Initial Yield with 11% Annual Dividend Growth & 5.5% Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 0.501.00%$ 1,000
End 5 Years21.1012$ 65.35$ 0.841.29%$ 1,379
End 10 Years22.6104$ 85.41$ 1.421.66%$ 1,931
End 15 Years24.7155$ 111.62$ 2.392.14%$ 2,759
End 20 Years27.7192$ 145.89$ 4.042.77%$ 4,044
Total Return 20 YR CAGR:7.24%
Total Dividends Received:$ 778
Forward Annual Income:$ 112
2% Initial Yield with 10% Annual Dividend Growth & 5% Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 1.002.00%$ 1,000
End 5 Years22.2456$ 63.81$ 1.612.52%$ 1,419
End 10 Years25.4401$ 81.44$ 2.593.18%$ 2,072
End 15 Years30.1293$ 103.95$ 4.184.02%$ 3,132
End 20 Years37.2904$ 132.66$ 6.735.07%$ 4,947
Total Return 20 YR CAGR:8.32%
Total Dividends Received:$ 1,657
Forward Annual Income:$ 251
3% Initial Yield with 9% Annual Dividend Growth & 4.5% Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 1.503.00%$ 1,000
End 5 Years23.4334$ 62.31$ 2.313.71%$ 1,460
End 10 Years28.4911$ 77.65$ 3.554.57%$ 2,212
End 15 Years36.256$ 96.76$ 5.465.64%$ 3,508
End 20 Years48.8014$ 120.59$ 8.416.97%$ 5,885
Total Return 20 YR CAGR:9.27%
Total Dividends Received:$ 2,612
Forward Annual Income:$ 410
4% Initial Yield with 8% Annual Dividend Growth & 4% Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 2.004.00%$ 1,000
End 5 Years24.6653$ 60.83$ 2.944.83%$ 1,500
End 10 Years31.7639$ 74.01$ 4.325.84%$ 2,351
End 15 Years43.0943$ 90.05$ 6.347.04%$ 3,881
End 20 Years62.2542$ 109.56$ 9.328.51%$ 6,821
Total Return 20 YR CAGR:10.08%
Total Dividends Received:$ 3,614
Forward Annual Income:$ 580
5% Initial Yield with 7% Annual Dividend Growth & 4% Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 2.505.00%$ 1,000
End 5 Years25.9414$ 59.38$ 3.515.91%$ 1,540
End 10 Years35.2564$ 70.53$ 4.926.98%$ 2,487
End 15 Years50.6256$ 83.77$ 6.908.24%$ 4,241
End 20 Years77.5581$ 99.49$ 9.679.72%$ 7,716
Total Return 20 YR CAGR:10.76%
Total Dividends Received:$ 4,627
Forward Annual Income:$ 750
6% Initial Yield with 6% Annual Dividend Growth & 3% Price Growth
TimeSharesPriceDiv/ShareYieldValue
Purchase20$ 50.00$ 3.006.00%$ 1,000
End 5 Years27.2621$ 57.96$ 4.016.93%$ 1,580
End 10 Years38.9648$ 67.20$ 5.377.99%$ 2,618
End 15 Years58.8142$ 77.90$ 7.199.23%$ 4,582
End 20 Years94.53$ 90.31$ 9.6210.65%$ 8,537
Total Return 20 YR CAGR:11.32%
Total Dividends Received:$ 5,617
Forward Annual Income:$ 909

In the second scenario, the total value of the six portfolios after 20 years varies greatly. The low yield, high growth portfolio generated slightly more income as the reinvested dividends purchased more shares than in the first example. However, the lower share price growth rate greatly reduced capital appreciation during the period.

The final share price for the high yield, low growth portfolio was also lower but this was offset by dividend income, which received a much larger boost as a result of the higher yield and compounding of reinvested dividends than in the low yield portfolio.

This resulted in a variance of income generated by the portfolios from $778 to $5,617, a difference of 622%, while the final value of the portfolios varied from $4,044 to $8,537 or a difference of 111%.

When comparing the two scenarios you can see how the low yield, higher growth portfolio had much lower total returns (7.2% CAGR vs. 12.0%) when the annual share price increases were halved. Meanwhile, the total return for the high yield, lower growth portfolio dropped much less (12.3% vs. 11.3%) because the majority of the portfolio increase was a result of the compounding effect of the increasing dividend.

This is a perfect example of why Chowder frequently touts the attractiveness of building a portfolio core around high quality, higher yielding utilities, tobacco companies and REITs. Even during tough times when stock prices are down or maybe not growing at a rate that matches earnings and dividend growth, the compounding effect of reinvesting the dividends really works to your advantage over time.

Real-World Examples

Obviously, stocks in real world portfolios don't appreciate in a linear manner like these fancy spreadsheets do, but there are some examples of companies that fairly closely resemble the variables used in them.

Here is a list of 6 companies that could be used to represent the scenarios put forth in the spreadsheets. The information for the 20 year dividend growth rates and total return values are taken from F.A.S.T. Graphs.

NAMESYMBOLPRICEYIELD20 YR DGRCHOWDER #TOTAL DIVIDENDS20YR Value
Family Dollar Stores Inc.(NYSE:FDO)$ 68.501.5%12.2%13.7$ 1,542$ 16,277
Deere & Company(NYSE:DE)$ 82.872.5%9.4%11.9$ 1,564$ 9,941
Air Products & Chemicals Inc.(NYSE:APD)$ 96.532.9%9.4%12.3$ 1,360$ 6,579
Conoco Phillips(NYSE:COP)$ 63.534.2%8.9%13.1$ 2,468$ 7,888
Altria Group(NYSE:MO)$ 36.504.8%5%9.8$ 3,669$ 5,654
Universal Health Realty Income(NYSE:UHT)$ 43.475.8%2.1%7.9$ 6,355$ 11,730

While the end results don't exactly match the spreadsheets, they do generally follow the trend. The worst case scenario from the stocks selected is a final portfolio value of $5,654 from Altria, which is still a very respectable 9.3% annualized rate of return on the $1000 initial investment. The best performer of the group is Family Dollar Stores, which posted an impressive 15.3% CAGR over the period.

It's also interesting to note that all six companies paid out at least 136% of the initial investment in dividends over the 20 year period, with Universal Health paying out an amazing 6.36 times the initial investment in dividends in just 20 years.

Conclusion

There has been endless debate in the comments section of Seeking Alpha articles on whether it is better to invest in low yield, high growth companies or high yield, low growth companies for a dividend growth portfolio. In my opinion it boils down to individual investor preference and the stage in life their investments are at.

A younger person with many years to retirement may chose to have the higher growth companies in hopes of catching a shooting star that leads to huge total returns during their accumulation phase of investing. Meanwhile, an older investor nearing retirement will likely lean more towards the greater yields which provide a better factor of safety and higher income for when they are ready to turn off the DRIP and start taking withdrawals.

My personal strategy has been to invest in the best of both worlds and go with a blended strategy with my portfolio. If you are interested in seeing what I am currently invested in, I published an update early last week showing my holdings. There are also several other contributors on Seeking Alpha who provide regular updates to their portfolios to share ideas with readers.

Just as in everyday life, there is no way to predict the future when investing in the stock market. However, the power of compounding provides a nice insurance policy when you invest with a long term focus in companies with a history of reliable and increasing dividends.

Source: Chowder Rule Breakdown - High Growth Vs. High Yield In Your Portfolio