So what's better? Dividend growth or dividend yield? The answer depends on your time frame.
This is my first article. There's already a lot of information on dividend growth and dividend yields but I wanted to share just one criterion that I like to see when I make a purchase. That is achieving a yield on cost (YOC) of 10% after 10 years.
Let me first explain what YOC is and how YOC is calculated. Yield on cost is defined as the current annual dividend divided by the average cost per share.
Let's give an example. Suppose I purchased 100 shares of XYZ Company for $10 per share. XYZ pays an annual dividend of $.40 per share at time of purchase (i.e., a current yield of 4%). Assume several months go by and XYZ's price per share rises to $16 and the yearly dividend is increased to $.50. XYZ's current dividend at that time is $.50/16 or 3.125%. However my YOC is $.50/$10 or 5%. For this example my YOC has increased from 4% to 5%.
I wanted to see how fast I could grow my dividend income realistically over 10 years and see how much of an effect dividend growth has versus dividend yields.
I created a spreadsheet with 7 different investment options. They are all achieving a YOC of 10% after 10 years. We will call them A-G. I am starting with $26,000 invested with $26,000 of contributions in year 1. The Value columns are the portfolio value at the end of each year after purchases are made. The Income columns are each year's total dividend income. All dividends are accumulated until the end of the year when all purchases are made. Also, I am assuming no change in share price of stocks since I only care about income produced.
The variables are: Initial Investment, Initial Contribution, Contribution Increase per year, Last Contribution Year, Dividend Yields and Dividend Growth.
Note: I removed B, E, F columns and formatted as best I could so it was readable on the page. If anyone knows of a better way of taking a screen shot that when resized still looks good please let me know.
right click to enlarge
Let's look at Columns "Income C" and "Value C." These columns assume that you are ONLY buying stocks yielding 4% with a dividend growth rate (DGR) of 9.75%. Notice also that I am increasing the amount of money I'm contributing by 20% each year for 10 years. After 10 years I'm not contributing any additional money, I'm only reinvesting with dividends earned.
The value at the end of 10 years is $820,908 with a dividend income of $31,316. Compare this to investments into A (5% yielders with 7.25% DGR). The income of A after 10 years is $35,907, more than $4000 more than Investment C. However, by year 20, Investment C is generating about $7000 more than Investment A due to the higher dividend growth.
I have 7 sample dividend yields and their respective growth rates. I typically try to target stocks that I believe will achieve a 10% YOC after 10 years. There's many different combinations as you can see from the table. I could invest in a stock yielding 5% with a DGR of 7.25% to achieve my 10% YOC goal after 10 years or I could invest in a stock yielding 2% with a DGR of 17.5%.
I believe these investment options are realistic. For example: Investment C could be a company like Waste Management (NYSE:WM) with a 4.08% yield and 5-year DGR of 8.86%. Investment E could be a company like Norfolk Southern Corp. (NYSE:NSC) with a 2.87% yield and 5-year DGR of 19.08%. How about an investment in Novartis (NYSE:NVS) with a current dividend of 4.5% and 5-year DGR of 18.15%? If this rate holds for 10 years your 10-year YOC Of Novartis would be an incredible 23.85%.
How about Hasbro (NASDAQ:HAS) with a current yield of 3.3% and 5-year DGR of 20.67%? If that held up, then Hasbro would have a 10-year YOC of 21.6%. Most DGR investers might pass up Wal-Mart Stores, Inc. (NYSE:WMT) with a lower initial yield of 2.5%. It would be similar to Investment F. It's 5-year DGR is 15.72%. If I believe this rate can hold it would meet my criteria since it would have a 10-year YOC of 10.77%. Don't forget McDonald's Corp. (NYSE:MCD) with a 2.7% yield and a 5-year DGR of 24.85%. This would provide a 10-year YOC of 24.8%.
The values for all of the selections stay fairly close together. The income stream does not. I believe it's interesting how quickly after the last contribution in year 10 that the income stream of G catches up and eventually passes the income stream of A.
Another point to mention is that you don't have to just invest in 4% yielders with a DGR of 9.75%. You could invest half you money in 5% yielders and half of your money in 3% yielders to achieve the same result as long as they have a DGR that will produce a 10 year YOC of 10%.
Someone closer to retirement would most likely prefer a higher yielder for more income now versus someone younger with 20 years left until retirement.
As I mentioned, this is only one measure I like to use when evaluating a stock for purchase. Do your own due diligence.
It's really all about your timeline.
For anyone interested, you can download the full spreadsheet from my blog and play around with the numbers. I welcome any comments.