To Hold Or Not Hold A Cash Position In A Dividend Growth Portfolio? This Finding May Surprise You

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Includes: KO
by: Accelerating Dividends

Summary

The idea of holding a cash position in a dividend growth portfolio is a spirited debate with good points supporting each side.

The purpose of this article is to evaluate whether the deployment of cash at a later time results in less dividend income over time.

The findings suggest that waiting for a better entry point can result in greater total dividend income over time.

A 5% price decline is all it took for the total dividend income to surpass the amount collected compared to an investor that bought when cash was available.

To hold or not to hold cash? That is the question posed by some dividend growth investors. It is also a topic that causes a spirited debate. The goal of dividend growth investors is to generate passive income from their investments. So therefore, why would you hold cash? Here are some of the trains of thought for having a cash position:

Pros

  • Wait for better entry price which results in a better yield on cost
  • Lower price can equate to more shares which results in more dividend income
  • Permits the investor to buy stocks at opportune times (e.g. market weakness)

Cons

  • Money that is not invested is not producing dividend income
  • Can always cost average down
  • Cash not invested generates no return (e.g. capital gains)

The one question on my mind is whether or not by holding a cash position and waiting to deploy it at a later time actually reduces the total amount of dividend income generated over time?

Analysis

To answer this question, I am going to use Coca-Cola (NYSE:KO) as my example. At the time of writing, KO was trading at $43.53 and was offering an annual dividend of $1.40. This represented a dividend yield of 3.22%. Based on the Dividend Champion, Contender and Challenger list prepared by David Fish, KO's 5-year dividend growth rate was 8.40%. I have also calculated KO's 5-year compound annual growth rate to be 5.33%.

For this example, I will use an investment of $10,000. Investor A purchases $10,000 worth of KO's stock at a price of $43.53, he would own approximately 230 shares (rounded up or down for simplicity). This would mean that in the first year, a total of $321.62 in dividends would be collected. To make this model work for the next 25 years, I am going to assume that KO raises its dividend by its current 5-year DGR each year. The following graph shows the amount of dividend paid out in each of those years. This example does not include a DRIP.

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I am now going to compare the total amount of dividends collected from this direct purchase and compare it to the total amount of dividends collected from a purchase that occurs one year later in which the stock price has dropped 5%. Why the total amount of dividends collected? The reason is because if we compare it to dividends paid that year, the amount will always be greater for the position that was initiated at a lower price because more shares were purchased which produces more dividend income. What we want to see is whether an investor ever catches up after waiting 1 year to the total amount of dividends they would have collected if they had just bought the stock when they had the cash on hand.

The scenario is now 1 year later. KO is trading at $41.46. Investor B decides that now is a good time to purchase KO and she also has $10,000 to invest. This investment purchases 241 shares which is 11 shares more than investor A. Does investor B ever catch up to investor A in the total amount of dividends collected over 25 years? The answer is yes.

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In year 13 of investor A owning the stock or year 12 for investor B, investor B would have collected $7113.85 in total dividends compared to investor A's $7096.71.

Would it be possible to wait 2 years and still catch up? Let's assume that the stock price 2 years later from investor A's initial purchase is still 5% less at $41.46 and that's when investor C decides to buy. He now owns 241 shares of KO. The answer is still yes.

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In year 21 of investor A owning the stock or year 19 for investor C, investor C would have collected $17028.79 in total dividends compared to investor A's $17000.54.

That's fairly interesting! Now the question becomes, does this still work if the dividends were DRIPed. I will attempt to answer that question as well.

In this scenario, KO stock price is going to appreciate by its 5 year CAGR each year. The dividend will continue to rise each year by its 5 year DGR. Investor A initiated his position in KO by investing $10,000 when KO traded at $43.53. He owns 230 shares. Investor B waiting 1 year when KO dropped 5%. She invested $10,000 and purchased 241 shares at $41.46.

Does investor B ever pass the total amount of dividends collected by investor A? The answer is yes.

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In year 19 of investor A owning the stock or year 18 for investor B, investor B would have collected $21941.63 in total dividends compared to investor A's $21933.53. It is interesting to see that a DRIP prolonged but did not prevent investor B from surpassing investor A. A 2 year comparison was not undertaken as it is expected to exceed the 25-year time frame.

Conclusion

This analysis shows some support that over the long term, an investor that waits for a better valuation can lead to greater total dividend income given enough time. It may not be recommended to exceed 2 years unless the price decline exceeds 5%. This would only reduce the amount of time before an investor who waited surpasses the total dividend income of an investor who bought directly.

Many dividend growth investors tend to buy and hold and have fairly strict guidelines for selling. A 25-year time frame seemed appropriate for this analysis however if an investor does not plan to hold the stock over such an extended period of time, it becomes evident that a direct purchase will lead to great total dividend income that a delayed purchase.

Having said all this, there are many factors that can come into play such as the ability to cost average down, unexpected growth for the company that may prevent investors who are waiting to initiate a position from doing so. One never knows what the future will hold. So, when you make your purchase, you should be happy with it, come rain or shine over the short term.

I welcome your thoughts and suggestions in the comments section. I know that this article will not put the debate to bed. I encourage readers to offer their opinions on whether to hold a cash position, whether they do or not and why.

Disclosure: I/we 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.