Recently I came across the following headline: "3 High-Yield Dividends That Could Triple Your Investment in Less Than 25 Years." Within this commentary, three people named three dividend stocks that they believed would triple your investment in two and a half decades or less: Realty Income (NYSE:O), HCP (NYSE:HCP) and Las Vegas Sands (NYSE:LVS).
Now to the casual observer this might sound impressive. Here you these three picks out of hundreds (or thousands) of options. The nonchalant viewer could believe this gives them some insight. Yet here's the thing: whether using the above names or hundreds of others, this type of expectation doesn't tell you much. It's always important to keep the relative time frame in mind.
When you see the word "triple" you can imagine a $1,000 investment turning into $3,000. We know what the word "triple" means, and it's easy to get carried away with its anticipation. We also know, if only from a vague bird's eye view, the notion of a 25-year investment time horizon. However, many of us aren't particularly adept at mentally calculating compound annual growth rates.
For an investment to triple over a 25-year period it would require a yearly growth rate of about 4.5%. Suddenly the idea of a spectacular investment opportunity turns to mediocre; and it all relates to the time frame. In fact, if a higher-yield security didn't triple your investment during the next 25 years you'd likely be quite disappointed.
Let's use some examples to demonstrate what I mean. AT&T (NYSE:T) is perhaps the quintessential "high-yield" dividend growth example. AT&T has not only paid but also increased its dividend for 31 consecutive years. Over the past seven years the payout boosts have been "just" four cents per annum - resulting in growth in the 2% to 3% range. Although the growth rate is comparatively slow, the current yield - sitting near 5.5% - makes up for it. Moving forward it's not unimaginable that AT&T will continue to increase its dividend by 2% per year.
If AT&T were able to increase its dividend by 2% annually, today's $1.88 payout would turn into a $3.08 payment 25 years later. This isn't spectacular growth by any means. However, it is more than solid income generation. Over the years you would expect to collect over $61 in dividend payments - representing about 175% of your initial investment. Without considering price appreciation you would already be quite close to tripling your investment.
Of course this would also imply a future yield around 9% - possible, but perhaps not altogether practical to expect. With slight share price appreciation (less than 2% per year) you would have more than tripled your investment. It's plain to see that isn't an especially high hurdle.
Another solid example might be a company like Kinder Morgan (NYSE:KMI). The "current" yield (4.8%) is a bit lower, but the anticipated growth is much higher. The company expects to be able to increase its dividend by 10% a year over the next five years. Let's scale this back slightly: call it 8% growth for the next five years, followed by 5% dividend growth thereafter.
In this scenario, today's $1.92 payout would turn into a $7.50 dividend payment after 25 years. You would expect to collect $110 or so in dividend payments - representing 275% of your initial investment. Without thinking about share price appreciation or reinvestment, you would already have tripled (and almost quadrupled) your investment. Of course this would also mean that shares would be trading with a 19% dividend yield in the future. Show me this world and I'll show you a place to invest.
If the future dividend yield were closer to say 5%, this would imply a share price closer to $150 and a total value near $260. In other words, instead of thinking about tripling your investment, you would be thinking about generating 6 or 7 times your investment. And remember, this isn't some "pie in the sky" notion. The growth expectations are actually scaled down a bit, and the $260 future number represents annual returns of under 8%. It's all too easy to get caught up in the magnitude of an investment multiple (three or six times your investment!) without consulting the time frame involved.
Of course we're looking at a higher yielding securities, but that need not be the case. A simple index fund, say the S&P (NYSEARCA:SPY), could easily triple your investment over the next 25 years. If you take a 1.9% yield and expect it to grow by 6% per year, you end the two and a half decade period with an 8% yield on cost; perhaps the market as a whole trades with this yield, or perchance you see a bit of capital appreciation. Even with a 4% future yield, this would still triple your investment. While a 2% future yield would mean waking up 25 years later to an investment that is five times higher than when you started.
In short, it can be all too easy to become enamored with "tripling" or otherwise multiplying your investment without also considering the time frame involved. It's a pretty good bet that a security that presently yields above 4.5%, with a dividend that is expected to grow, might generate annual returns over 4.5%. That's obvious.
Over 25 years, "tripling" simply means 4.5% annual returns. With a long enough time frame, and a collection of wonderful businesses, you're going to have a much higher balance in the future. It's hard to not get richer over time when you consistently hitch your fortunes to profitable enterprises. The question isn't whether today's investment will be multiplies higher, the true measure is whether or not it helped you toward your investing goals.
Disclosure: The author is long T, KMI, O. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.