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: Archer-Daniels Midland (NYSE:ADM) and Sysco (NYSE:SYY)
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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 ADM exceeds that of Sysco by 3.5%. The one year growth rate difference is even larger. For this example I will assume that ADM's dividend grows at the five year rate of 9% and Sysco maintains a growth rate of 5.5%. I ran the following results in our free calculator called Dividend Yield And Growth.
It takes 17 years for the YOC for ADM to break even with the YOC for Sysco. Of course, due to compounding we see the YOC for ADM 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 17 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.
Another interesting way to look at this is, what does ADM's dividend growth rate have to be in order for the returns to break even after 10 years? I kept Sysco's dividend growth rate set at 5.5%. It turns out that ADM's dividend must grow at a 19% annual rate in order for the returns to break even after 10 years. In order for the compounded returns to break even after 20 years, ADM's dividend growth rate must be 12%.
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.
Lastly, I have found by plugging in various dividend yields into our Retirement Planner that finding dividend payers who 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 who will either pay a strong dividend or have serious dividend growth and have shown a culture of not cutting dividends when times get tough.
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.