A Stock With A Better Dividend Than AT&T?

| About: 3M Company (MMM)

Summary

Recently I came across an idea that 3M was a “better” dividend stock than AT&T.

While the anticipated growth rate may be higher, there’s more to it than that.

This article explores the benefit of a higher starting yield and the timeframe involved.

Recently I came across an article touting stocks with "better dividends" than AT&T (NYSE:T). The first company mentioned was 3M (NYSE:MMM). The lower yield was brushed over, and instead things like the past increase rate, length of the company's dividend increase streak and potential for future payout growth were highlighted. The conclusion was in 3M's favor. Yet I think this can be a dangerous way to think about the income world.

We all know that a higher growth must eventually win out. That's just math. Yet remaining cognizant of the timeline involved (along with the potential for being wrong) are just as vital in my view. Let's come up with an example to get a better feel for how this might work out.

Over the past decade AT&T has increased its dividend by an average compound rate of just over 3%. For the past eight years the company has increased its payout by just a penny per quarter, or four cents each year. () The most recent increase, from $0.47 to $0.48, represents an increase of about 2.1%. So let's use 2% annual dividend growth for AT&T as our baseline - that's the sort of "slow growth" that everyone talks about.

During the past decade 3M has increased its dividend by over 9% annually. Through this period the payout ratio has gone from about 35% to over 50%. While additional payout expansion is possible, you'd likely anticipate that future growth would more or less be in line with future earnings growth. Naturally we don't know what this will be, but analysts are estimating that intermediate-term growth could be in the 8% range. We'll use this as our dividend growth baseline for 3M.

When it's phrased like that - "2% growth versus 8% growth" - it's obvious to see that the higher growth rate must eventually win out. And if both securities had similar yields, you'd naturally go with the higher expected growth rate. Of course, you're not starting with the same yield. AT&T's current payout is much greater than 3M's thus making the comparison a bit more difficult.

Based on a share price around $39 and a $1.92 annual payout, AT&T's "current" yield sits around 4.9%. Based on a share price of around $169 and a $4.44 annual payout, 3M's "current" yield is about 2.6%. This nearly doubled disparity makes a difference. It means that 3M, despite the faster growth rate, won't be producing more income than AT&T anytime soon.

If you were to just look at the amount of annual cash that you would receive, here's what that would look like per $100 invested:

As you can see, in the first year AT&T starts with a sizable advantage. From there 3M consistently grows its payout quicker than AT&T and by the 13th year you would anticipate receiving more dividend income from the lower starting dividend yield; and the "fast growth camp" cheers.

Yet I think it's important to remain cognizant of a variety of items. First, 13 years is a whole lot of anticipation. If you're thinking about generating more income in 5 years or 10 years, AT&T is still the winner on an annual basis. Even more important, in my view, is the idea that the above demonstration is only on a yearly basis. It doesn't account for the increased income benefit in all of the prior years.

If you consider all of the payments in the aggregate, it would take 3M closer to 21 years before you received more nominal income. Think about that. Before you automatically declare 3M the "better dividend" you have to first consider whether or not you have a 20-year timeframe. A lot of people give long-term investing lip service, but not as many are actually carrying out two decades worth of holding periods in practice.

Yet even if this is the case, we're still not done. The above gives credit for the larger payments to start out on a nominal basis, but it doesn't yet account for the ability to reinvest the higher starting dividends.

A lot of people see a company like AT&T with its 2% dividend growth rate and think that's not especially attractive. Yet if you're reinvesting, your total income growth could be much higher. Not only do you get 2% "organic" growth, but those funds also provide an extra ~5% or so in income based on the current yield at the time of reinvestment. So instead of your income going from say $100 to $102, as many mentally imagine, your total income can go from $100 to $107. When you're already starting out with an above average dividend yield, this has a meaningful effect.

It should be noted that the same thing happens with 3M. While the dividend growth may be 8% annually, your total income growth could be closer to 10% or 11% per year as a result of reinvestment.

So if you run that comparison, AT&T's total income growth if reinvesting at around 7% annually versus 3M's at 11%, it takes about 28 years before 3M is the "winner." That's an important consideration to keep in mind, in my view. We all know that a higher growth must eventually win out, and it's easy to tout the higher growth rate of another firm or a stodgy "slow grower." Yet I think that it's equally important to actually run the numbers to get a feel for the timeframe involved. If you're investing for 10 or 20 years, it could very well be that the AT&T investment still remains as a "better" dividend decision.

Moreover, all of this is presuming that 3M's growth remains superior for the next three decades. Should the dividend growth rates converge a bit - a bit higher for AT&T or lower for 3M - all of this could be for naught. AT&T would remain as the better dividend decision for even longer.

So it's not enough to look at a faster growth rate and automatically conclude that it is better. Of course you can make a different case for total return (and should come up with expectations on this side as well), but on the income front AT&T's much higher starting yield creates a substantial hurdle for the next couple of decades. If you're looking to oust AT&T's dividend income advantage sooner, your alternative security needs to have a higher starting yield or even faster growth rate.

Disclosure: I am/we are long T.

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.