Joe Eqcome

Why Choose Low Yield over High Yield Stocks?

The underlying assumption of your thesis is that lower yielding stocks with greater dividend growth rates would sell at a higher future stock valuation. This share price appreciation would offset the initially higher cash dividends of companies with higher dividend growing at a slower rate. This is a reasonable assumption for long-term investors for the examples you've provided.

In your example, both for a 5 and 10 year holding period, assuming the stock’s value at the end of the holding period is based on the last year’s dividend divided by the now current yield, investors are better off owning low yielding, higher growth dividend stocks. They have higher IRR's. (Interestingly, this is also holds true if the yield proportionately declines 50% or increase 100%.)

If however, the yields of lower, higher yielding stocks do not change proportionately, due to a specific set of economic or financial circumstances, it is possible higher yield, lower growth stocks could do better.

This would be the case if the higher yielding lower growing stocks were selling at a greater discount to their intrinsic value than the lower yielding stocks due to investors’ risk assessment.

If that discount for the higher yielding stocks at some future point were to narrow as risk assessment eased, it would impact their yield multiple favorably relative to the low yield, high growth stocks.

The other case where high yield, low growth stocks may do better is in very short holding periods. This might be the case in the trading of high yielding stocks in the face of a sharp easing in risk assessment or declining interest rates. In this case, you may get a near-term spike in the share price.

However, for long-term investors, lower yielding, higher growing dividend stocks may be a better choice.

The key in either case is to focus on their respective free cash flows.

Joe Eqcome