Seeking Alpha

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: Eli Lilly (LLY) and Intel (INTC).

 Yield 1 Yr Div Growth 5 Yr Div Growth Payout Ratio LLY 4.8% 0% 1% 51% INTC 3.3% 16% 22% 34%

These two companies are very clear contrasts in dividend strategy. Eli Lilly has a higher dividend yield, but the dividend growth rate leaves a lot to be desired. The average annual growth rate of the dividend over the past five years is barely 1%.

Although Intel has a lower yield, its prospects for dividend growth are much better. The five year dividend growth rate is simply stellar at 22% and their payout ratio is a healthy, low figure of only 34%.

In order to compare and contrast these two stocks, I want to show readers 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 current annual dividend divided by the original investment in the company's stock. I ran these calculations using our publicly available calculator called Dividend Yield And Growth. Starting with the simplified assumption that the growth rate of dividends for Eli Lilly is 1% and Intel's averages 12% over the next 20 years, we see the following:

(Click to enlarge)

It takes about four years for the YOC for Intel to break even with the YOC for Eli Lilly. Of course, due to compounding we see the YOC for Intel explode upward eventually. But this assumes that the company can continue its relatively high rate of dividend growth going forward.

Looking at the compounded returns over time, it takes about eight years for the compounded total return due to dividends to break even with Eli Lilly, 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.

If I'm investing for the long-haul I know which dividend payer I'm choosing between these two. I would buy and hold Intel for retirement and watch my yield on cost rise dramatically over time.

It is also important to note that dividend growth stocks like Intel can help a retirement plan immensely, especially vs. low-yielding treasury bonds. I placed Intel into a sample retirement portfolio into our retirement planner in place of the ten treasury bonds that were in the portfolio before.

I found that if a typical 55 year old couple with \$400,000 in assets moves 50% of their funds from treasuries to a dividend payer with growing dividends like Intel, over ten years they will have increased the time that their funds last in retirement by over twelve years.

When constructing a dividend portfolio for the long-run, it is important to keep in mind just how important dividend growth is over time. Selecting companies who have consistently strong dividend growth can mean the difference between early retirement and working a lot longer.