Seeking Alpha
Dividend growth investing, retirement
Profile| Send Message|
( followers)  

Introduction

In "10 by 10 The Interaction of Dividend Yield and Growth," I discussed the interaction of various initial dividend yields (IY) with various dividend growth rates (DGR).

The context of the original 10 by 10 concept relates to achieving a target: 10% yield on cost in 10 years from dividend increases alone. In other words, given a particular starting yield, how long does it take to get to the target for various rates of dividend growth? (Dividend reinvestment, which speeds up the process, is ignored.)

After seeing a lot of comments expressing interest in high-DGR stocks with lower initial yields, I decided to revisit the original concept with more focus on those kinds of stocks.

Obviously, it takes longer for a stock with a lower yield to achieve a 10% yield on cost (or any target) than a stock with a higher IY if the DGRs are the same. But if a stock can maintain a high DGR for many years - a big "if" that is discussed later - it will catch up and then surpass the annual dividend payout of a stock that had a higher IY. And each year beyond the crossover point, obviously, the high-DGR stock will widen its lead on a payout-per-year basis. (It may, however, take several years to catch up on a cumulative basis.)

For the basic table here, I have extended IYs down to 2.0% and DGRs up to 20%/yr. My former cutoffs had been 3.0% and 15%/year, respectively. The target changes from 10 by 10 to 10 by 15: Achieving a 10% yield on cost within 15 years. That gives higher DGRs more time to work.

The table below shows IYs across the top and DGRs down the side. The cell where a combination intersects displays the number of years it would take that stock to achieve 10% yield on cost given the initial yield and dividend growth rates that you selected.

(click to enlarge)

I have shaded the combinations of IY and DGR that achieve the target.

In the table above, the DGRs should be considered CAGRs-compound annual growth rates. It is rare for a company to increase its dividend by the exact same percentage each year. In calculating the table's values, all years were rounded to the nearest year that a 10% dividend return would be achieved. Thus all years appear as whole numbers. Returns were also rounded, so the year that a return reached 9.6% was counted as the year it hit 10%.

Dividend Reinvestment

The table does not demonstrate the accelerating effect of reinvesting the dividends. Reinvesting dividends shortens the time for a portfolio's dividend growth to build up, as shown in my recent article about my own Dividend Growth Portfolio, which is now more than 5 years old.

There, I estimated that the current income from my portfolio is 41% more than it would be had I not reinvested dividends along the way. The table above just shows the increase in yield on cost from dividend increases themselves.

Can Stocks Grow Dividends That Fast for That Long?

From the comments I have seen, dividend growth stocks with high dividend growth rates are especially appealing to younger investors. That makes sense, as younger investors can look forward to decades of compounding before they retire.

But I get worried that some may think you can count on a stock to maintain a high DGR for years and years. You can't. It may happen, but you can't count on it.

Let's look at some data. The following table shows how many companies have raised their dividends at least x% (down the left side) for how many years (across the top). This data is from Robert Alan Schwartz's Tessellation site, and it is complete through the end of 2012; here is the link.

(click to enlarge)

What the table tells us is that the number of companies that can maintain high DGRs every year dwindles fast with each passing year.

For example, only 14 companies were able to maintain dividend increase streaks of 10% per year for 10 years through 2012. Of these, only 7 have yields above 2.0%, and only one, Lockheed Martin (NYSE:LMT), has a yield over 3%. Here are the other six:

--Fastenal (NASDAQ:FAST), but it cut its dividend in 2013 (per David Fish's Dividend Champions)

--Harris (NYSE:HRS), yield = 2.8%

--Owens & Minor (NYSE:OMI), yield = 2.8%

--Wal-Mart (NYSE:WMT), yield = 2.5%

--Walgreen (NYSE:WAG), yield = 2.3%

--John Wiley & Sons (NYSE:JW.A) (NYSE:JW.B), yield = 2.1%

If we raise the requirement to a DGR of 15% per year for 10 years, only two stocks have done it: Ross Stores (NASDAQ:ROST) with a 0.9% yield and Stryker (NYSE:SYK) yielding 1.6%.

The data above requires that the company has increased its dividend by at least 10% or 15% each year. Clearly, some companies can maintain an overall 10-year DGR of 10% without doing it every year. For that information, I turn to the Dividend Champions document cited above. Here's what I found:

  • Of 469 companies, 130 have 10-year DGRs of 12%/year or more (through the end of 2012)
  • Of those, 76 have yields of 2.0% or more.
  • Of those, however, 31 have obvious patterns of declining DGRs during the preceding 10 years. In other words, while they made the 10-year DGR cutoff of 12%, their dividend growth rates have been declining since then. Come January, when the new 10-year DGRs are computed, most of them won't make the cutoff.

Here are the remaining 45 stocks with yields of at least 2.0%, 10-year DGRs of at least 12%/year, and not displaying an obvious pattern of declining DGR.

Stock

Ticker

Yield

10-Year DGR

Aflac

AFL

2.3%

19%/year

Archer-Daniels-Midland

ADM

2.1

12

Automatic Data Processing

ADP

2.4

13

Becton-Dickinson

BDX

2.0

17

BHP Billiton

BHP

3.6

24

Caterpillar

CAT

2.9

12

China Petroleum

SAIP

5.1

15

Coca-Cola Enterprises

CCE

2.0

15

Computer Services

CSVI

2.1

17

Conoco Phillips

COP

4.0

15

Cracker Barrel

CBRL

2.9

53

CSX

CSX

2.3

23

Darden Restaurants

DRI

4.8

40

Deere

DE

2.5

15

Gap

GPS

2.0

18

General Dynamics

GD

2.6

13

Harris

HRS

2.8

27

Hasbro

HAS

3.4

27

HCC Insurance

HCC

2.1

14

International Business Machines

IBM

2.1

19

John Wiley & Sons

JW.A

2.1

17

Lockheed Martin

LMT

4.2

25

Lyons Bancorp

LYBC

3.4

16

McDonald's

MCD

3.4

28

Medtronic

MDT

2.1

16

Meredith

MDP

3.4

16

Molex

MOLX

2.5

24

Nippon T&T

NTT

3.6

18

Norfolk Southern

NSC

2.7

22

NV Energy

NVE

3.2

13

Occidental Petroleum

OXY

2.7

15

ONEOK

OKS

2.9

15

Owens & Minor

OMI

2.8

16

Raytheon

RTN

2.9

25

Southside Bancshares

SBSI

3.0

17

Span-American Medical

SPAN

2.6

15

Sunoco Logistics

SXL

3.6

17

T. Rose Price

TROW

2.1

16

Target

TGT

2.7

19

Texas Instruments

TXN

3.0

24

Union Pacific

UNP

2.0

20

United Technologies

UTX

2.0

15

United-Guardian

UG

3.6

24

Walgreen

WAG

2.3

21

Wal-Mart

WMT

2.5

18

Conclusion

A lot of seemingly attractive candidates appear among high-DGR stocks, worthy of more due diligence.

That said, be very cautious about thinking that a company with, say, a 10-year DGR of 15% will be able to maintain that pace for very long. It just does not happen often.

In contrast to the unknown future DGR, a stock's initial yield is locked in. Here's what I mean by that: If the company does not cut its dividend, the IY you get when you purchase the stock is the lowest yield on cost that you will ever have from that stock. The stock's current yield will vary up and down as the years go by, but if the company keeps raising its dividend, your yield on cost will only go up. Even if the company freezes its dividend the day after you buy it, its yield on cost will stay the same as the day you bought it. That is because the "price you paid" in the equation below never changes.

Yield on cost = Dividend payout / Price you paid

Therefore, absent a dividend cut, the dividend payout either rises (in which case yield on cost goes up) or stays the same (in which case yield on cost stays the same).

This latter point is important. The faster you hit your target, the fewer years that your stock choice is subject to what might be called "prediction risk" - the risk that you overestimated its rate of dividend growth. Your initial rate of dividend return is fixed at the time of purchase, but the future rate of dividend growth is somewhat speculative. The higher the rate of projected dividend growth, the more risk that it may not actually be achieved.

Source: 10 By 15: What Happens With Low-Yield High-DGR Stocks