One thing that I particularly like about SA is that there are so many talented people that are “thinking outside of the box.” This is especially evident when you search for articles that for whatever reason may not have had a large stream of commentary, but are nonetheless interesting articles, based on the author’s thinking process. Recently, I came across one of those articles. The article was, "Large Cap, High-Dividend Stocks: Waiting For Payback."
The author poses this question:
How long would it take for a dividend-paying stock to pay back the stocks original price? The time it takes for an investment’s cash outflows to sum to the original outlay is called the payback period, and it is considered a simplistic and crude measure of risk.
He then poses a methodology for examining the notion of payback and he lists a great number of stocks in his analysis and gives us an idea of when an investor would recover his/her initial investment through dividends paid. His closing statement offers a warning of sorts:
Since many dividend investors are attracted to high-paying dividend companies on the premise that they can ignore what the markets do and simply focus on their dividend income, the payback period provides a reality-check for what income investments will likely feel like. If you want to ignore what prices your securities fetch in the markets, you could be waiting a very long time to get paid back.
In looking at the method used to determine the “payback” I noticed what I thought were anomalies. For example, two stocks that I own, Altria (NYSE:MO) and General Mills (NYSE:GIS), were showing a payback period of 20 years. What caught my attention was the dividends for each company were very different. MO was listed as paying a dividend yield at 5.95% and GIS was showing a dividend of 3.12%.
To test the payback period for both of these companies, I made a little spreadsheet (as I am know to do on many occasions), since I am mathematically challenged. To keep it simple, I determined that each of the two companies would pay forward a dividend growth rate of 3%. Now, MO has actually increased its dividend by 9.2%, 18.3%, 14.8%, and 11.7 % over the 1-, 3-, 5-, and 10-year periods. It is a Dividend Champion. General Mills has increased its dividend 16.7%, 11.4%, 10.4%, and 6.7% in the same time frame.
Since many will argue that dividends are a result of earnings, and earnings as well as dividends might not continue at the same pace as historical models, I said, let’s err on the side of conservative estimates. Here’s what I found: MO, at the recent closing price of $27.10 and with a dividend of $1.64, would pay back your investment in 13.5 years. General Mills, on the other hand, with a recent closing price of $38.31 and a dividend of $1.22 per share, would take 22.5 years.
Looking at a metric of “payback” based on dividends received is a very interesting concept to me. If we look at a criteria of a 1-year, 3-, or 5-year dividend growth rate, we would obviously have better results than my random 3% assignment. The payback on MO, based on a projected 9.7% dividend growth rate (one year) would take that payback on the initial investment to a little over 10 years. At a dividend growth rate of 18.3% (3 years), MO would pay back the initial investment in a little over 8 years.
At the same time, selecting dividend growth stocks that also offer the opportunity for capital gains would accelerate that payback period. Selling a partial position would allow the investor to actually be working with “house money” and not their own. I know, but let me give another example:
Last year I purchased a position in XOM at $61.15 a share. I purchased 500 shares for a cost of $30,500. The shares were purchased on September 9, 2010. In April of 2011, I sold 350 shares at $87.50 and received $30,600 (my original stake in XOM) and kept 150 shares. That is worth $11,500 at today’s price and my yield on cost is my original 3%. I got my “payback” in 7 months.
As a dividend growth investor, it pays to be active in the management of your portfolio and to be aware of situations when there comes a time to take money off the table.