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Value, growth, portfolio strategy, dividend growth investing
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Here is my dilemma: I've become a bit confused recently regarding DGI and total return. After reading some great SA articles this past year in the dividend and income section, I've begun to revamp my retirement portfolio with a focus on dividend growth investing. I've started posting my rules and holdings on my blog. So far, so good.

Several articles and comments I've read recently tend to emphasize dividend growth rates vs. share price appreciation, favoring dividend growth above all else. It seems that some investors tend to ignore share price appreciation in favor of solid dividend growth. So I'm wondering whether I'm missing some important point here; my premise has always been that it's better to focus on total portfolio return while accumulating for retirement, then trade the big nest egg I've amassed at retirement for a high yielding, dividend growing portfolio once I need the income for those pesky living expenses. The "ignore share price" viewpoint piqued my curiosity. So, like the good engineer I once was (legend in own mind, etc.), I constructed some spreadsheets to look at some different scenarios.

First, I built my assumptions (inputs) that can and will be varied in the analysis:

I'm analyzing two stocks, XXX, a "growth" stock with no dividends vs. YYY, a dividend champion. Here is an example of the inputs for these two companies, from which I'll generate a spreadsheet:

In this scenario, XXX share price (=EPS Growth) will grow at a CAGR of 13% and pay no dividends, while YYY share price will grow at a CAGR of 8%, pay a starting yield of 3%, and grow the dividend at a CAGR of 5%. I'm hoping to retire 15 years from now, so I'll run the analysis for that time duration. Below is the spreadsheet I've built showing the two stocks and the final outcome in year "16," the start of my retirement (click to enlarge).

(click to enlarge)

In this first scenario, the 13% appreciation trumps the 8% appreciation + 3% initial yield + 5% annual dividend growth. At retirement (year 15) stock XXX is worth $645k vs. YYY worth $437k. If I sell all my XXX and buy as much YYY as I can, I'll have 19,716 shares paying the same dividend as the 13,800 shares in the DG scenario. More shares = more income, $11.7k vs. $8.2k. I know, I know, I can hear folks reading SA saying, "but your assumptions are wrong!" I agree the inputs have a huge effect, so here are six different scenarios varying the inputs. Looking at the results, I've drawn a few conclusions.

The results compare annual income from dividends for the two scenarios in each case. Case 1 shows the positive effect of dividends vs. no dividends with same price appreciation (growth). No doubt, dividends help.

Case 2 increases the growth rate from 8% to 11% for the non-dividend stock. The two outcomes are pretty close; interestingly, the 11% growth of XXX = 8% growth + 3% yield of YYY.

Case 3 ups the growth of XXX to 13%, the example in the spreadsheet up above. XXX is a clear "winner" here.

Case 4 increases the rate of annual dividend growth. Interestingly, both income streams benefit at retirement because the YYY stock is paying a much higher dividend in year 16, but we can still buy more shares with the XXX proceeds.

Case 5 is very interesting. By increasing my starting yield in year 1 to 5% from 3%, then growing the dividends every year by 10% vs. a growth stock at a respectable annual 13% growth rate, the dividend grower wins! This surprised me. The extra income from the higher yield, then compounded at 10% every year had a bigger effect than I anticipated. But hold on, let's look at one last case.

In case 6, I exchanged capital appreciation in YYY for yield. The 5% starting yield with a share price growth of only 5% (think utilities, or similar). The dividend grower again gets edged out in this scenario. It's also interesting to see that a reduction in price appreciation for YYY, positively effects the income in retirement of the growth case; this is due to the lower price, and subsequent increase in shares purchased upon retirement in year 16.

Conclusions (My Humble Opinions)

  • In this simple analysis, size of the egg at retirement is the only factor of importance (for an IRA), not how you got there. However, I'm ignoring factors that can't be ignored; risk, volatility, and taxes. Conversion of the "growth" scenario to an income portfolio at retirement is fraught with peril; tax bite if not in an IRA; big drop in the market in years 15/16, etc.
  • I think the point is, that you can get there either way, or a combination of both ways (Growth & DGI), but total return is key.
  • For the growth route, every 1% of total return makes a huge difference in the outcome; for the DGI route, investors need to monitor three things closely: share price growth, total portfolio yield, and dividend growth of the portfolio, they all matter. Though not borne out in this simple analysis, I suspect that monitoring the dividend of "great" companies, may be enough to ensure that price appreciation takes care of itself.
  • When DGI investors in the accumulation phase say they are ignoring share price fluctuations, that is fine in the short term, or when living from the dividends, but while accumulating, earnings growth and subsequent (highly correlated) share price growth should not be ignored.
  • As Chuck Carnevale writes, "Although the focus is often mostly on the dividend income, for many dividend paying stocks it is merely the icing on the cake. Whereas the cake is the capital appreciation component that is often overlooked in favor the yield."
  • Maximizing yield as a goal prior to retirement, and forfeiting growth in favor of yield, results in reduced income when you retire. The only way maximizing yield before retirement makes sense to me, is if you believe the ultimate total return will be greater as a result, or you are in a taxable account.

Disclosure: I 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.

Source: DGI And Total Return - A Few Scenarios