Seeking Alpha
Long-term horizon, dividend investing, dividend growth investing
Profile| Send Message|
( followers)  

Do companies that grow earnings faster, have a bumpier "ride" than companies that grow earnings more slowly?

Do companies that grow dividends faster, have a bumpier "ride" than companies that grow dividends more slowly?

To answer those questions, I will define the terms "compound annual growth rate," "bumpiness," and "correlation."

What is compound annual growth rate?

Consider two dividend growth companies, YYY and ZZZ.

YYY's dividend starts at $1.00 per share, grows by 16.739% each year, and reaches $8.73 in year 15:

yeardividendincreasepercent increase
1$1.00
2$1.17$0.1716.739
3$1.36$0.2016.739
4$1.59$0.2316.739
5$1.86$0.2716.739
6$2.17$0.3116.739
7$2.53$0.3616.739
8$2.95$0.4216.739
9$3.45$0.4916.739
10$4.03$0.5816.739
11$4.70$0.6716.739
12$5.49$0.7916.739
13$6.41$0.9216.739
14$7.48$1.0716.739
15$8.73$1.2516.739

YYY's dividend growth is smooth.

This smooth rate of growth is called the compound annual growth rate, or CAGR.

What is bumpiness?

ZZZ's dividend starts at $1.00 per share, grows by a different percentage each year, and reaches $8.73 in year 15:

yeardividendincreasepercent increase
1$1.00
2$1.64$0.6464
3$1.83$0.1911.585
4$2.28$0.4524.59
5$2.91$0.6327.632
6$3.64$0.7325.086
7$4.26$0.6217.033
8$4.90$0.6415.023
9$5.37$0.479.592
10$6.20$0.8315.456
11$6.78$0.589.355
12$7.42$0.649.44
13$7.52$0.101.348
14$7.84$0.324.255
15$8.73$0.8911.352

ZZZ's dividend growth is not smooth. It is bumpy. The less smooth, the more bumpy. The more bumpy, the rougher the "ride."

How bumpy is it? (No, this is not a Henny Youngman joke.) How do we measure bumpiness?

Bumpiness is a function of standard deviation. I use the formula:

bumpiness = (standard_deviation * 100) rounded to the nearest integer.

What is correlation?

Correlation measures "how two [data sets] move in relation to each other." From Investopedia: "Correlation is computed into what is known as the correlation coefficient, which ranges between -1 and +1. Perfect positive correlation (a correlation co-efficient of +1) implies that as one [data set] moves, either up or down, the other [data set] will move in lockstep, in the same direction. Alternatively, perfect negative correlation means that if one [data set] moves in either direction the [data set] that is perfectly negatively correlated will move in the opposite direction. If the correlation is 0, the movements of the [data sets] are said to have no correlation; they are completely random."

Correlation does not imply causality. This means that even if you and I have high correlation, it could be that (1) you cause me, (2) I cause you, or (3) something else causes both you and me, so no conclusions about causality can be drawn.

What is the correlation between CAGR and bumpiness?

My dividend web site tracks 886 companies, comprising all of David Fish's lists of Dividend Champions, Contenders, and Challengers, and more.

I chose to start with the year 2000, as since then the market has experienced two recessions:

(click to enlarge)

and the U.S. Government lost its AAA rating in 2011.

What is the correlation for dividends?

Five hundred eight companies out of 886 had sufficient dividend data to be worth comparing.

The raw data can be found here.

The correlation was 0.33935, which is positive, but not significant.

I used Excel to create a scatter plot with a trendline (see below). One company, Waste Management (NYSE:WM), is an outlier with a bumpiness of 2122 (literally, it was off the chart), so I removed it. The remaining 507 companies have a correlation of 0.345, so removing the outlier barely changed the outcome. The trendline (a "best fit" line) has an R-squared of 0.11912, so it is not a good fit.

(click to enlarge)

What is the correlation for earnings?

Four hundred fifty companies out of 886 had sufficient earnings data to be worth comparing.

The raw data can be found here.

The correlation was 0.192412, which is positive, but not significant.

I used Excel to create a scatter plot with a trendline (See below). Three companies [Genesis Energy LP (NYSE:GEL), Precision Castparts Corp (NYSE:PCP), and PartnerRe Ltd (NYSE:PRE)] were outliers, so I removed them. The remaining 447 companies have a correlation of 0.060, so removing the outliers reduced the correlation to virtually random. The trendline (a "best fit" line) has an R-squared of 0.0036, so it is not a good fit.

(click to enlarge)

Conclusion

Regarding the two questions at the top of this article:

Do companies that grow dividends faster, have a bumpier "ride" than companies that grow dividends more slowly?

Do companies that grow earnings faster, have a bumpier "ride" than companies that grow earnings more slowly?

The answer to both questions is "not in any significant way," which means you don't have to give up faster growth in order to get lower bumpiness, or vice versa.

Another way to see that CAGR and bumpiness are not strongly correlated is to go to my dividend web site, specifically the pages for dividends and earnings from 2000 to 2012. Starting in the upper left hand cell of 0% CAGR and 0 bumpiness, you can go as far to the right (increasing CAGR), or as far down (increasing bumpiness), or both, depending on your preferences for CAGR and bumpiness. Many combinations of row and column will give you some companies to choose from.

Part 2

Part 2 will compare earnings CAGR and dividend CAGR.

Acknowledgements

SA members David Fish, David Van Knapp, and richjoy403 (in alphabetical order) made significant and helpful suggestions on a first draft of this article. I am glad to thank each of them for their help.

David Van Knapp kindly pointed out his earlier article on a similar topic, which I was unaware of until after this article was written.

Source: On Comparing Earnings Growth And Dividend Growth, Part 1