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: Exxon (NYSE:XOM), the oil and gas giant, and Universal Corp. (NYSE:UVV), a 130 year old tobacco company.
XOM: | |||
Div Yield | 1 Yr Div | 5 Yr Div | Payout |
2.2% | 4.8% | 8.8% | 22.0% |
UVV: | |||
Div Yield | 1 Yr Div | 5 Yr Div | Payout |
4.2% | 2.2% | 2.2% | 68.0% |
There are clear differences in the two companies' dividend yields as well as their 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.
Starting with the simplified assumption that the growth rate of each dividend follows the five year growth rate, I calculated the following using our publicly available calculator called Dividend Yield And Growth:
It takes 12 years for the YOC for Exxon to break even with the YOC for Universal. Of course, due to compounding we see the YOC for Exxon explode upward eventually. But this assumes that the company can continue its relatively high rate of dividend growth going forward. Also, if we assume that Exxon's dividend growth rate continues at this high rate, the returns due to dividends will never break even in a 20 year time period, assuming dividends are always reinvested. 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.
Both of these companies have a very good history of increasing their dividends over time. However, Exxon has a much longer history of doing so as Universal has only been a public company since 1988. Also, Exxon has a much lower payout ratio, giving it more room to keep its dividend growth going, even in tough economic times. Lastly, Exxon has a lower debt load than Universal with a debt/equity ratio of 10% vs. 51%.
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.
Disclosure: I am long XOM.