Statistical Variances Between Monthly And Quarterly Paying Dividend Stocks

Includes: DLR, EPR, ETY, MAIN, O
by: Adam Aloisi


Monthly dividends seem to be an attractive lure for income investors.

A look at how much might be gained in terms of both accrued income and YOC.

How monthly pay should be viewed compared to other fundamental factors.

Three monthly payers that might be worth considering right now.

While the vast majority of publicly traded securities pay a dividend on a quarterly basis, a small but growing group pay monthly. And a lot of these entities usually go out of their way to let you know they do so. Realty Income (NYSE:O), for instance, has trademarked itself as "The Monthly Dividend Company." Many closed-end fund entities will also advertise the fact that their bond income is paid out monthly instead of the typical twice-a-year frequency of corporates and municipals.

Increased frequency of pay is certainly a benefit for those that need to realize a cash stream to meet ongoing obligations. But if you are poor at budgeting or tend to spend money mindlessly on credit outside your means, it probably won't matter much how often your investments pay you back. Still, for some, ownership of monthly dividend payers may help to develop discipline over more common fiscal miscues or, more generally, poor money management habits.

More importantly, investors should evaluate the statistical evidence and consider what monthly pay might mean in real terms over the near and longer term.

Dividend Reinvestment

One of the commonly mentioned pros to owning monthly payers is the compounding impact versus less frequent pay. However, when push comes to shove, this may not represent as huge an income spiff as many might think, especially if you are looking at securities with lower yields or lower dividend growth rates. To illustrate, let's take two REITs, aforementioned Realty Income - the monthly payer - and Digital Realty (NYSE:DLR) - a quarterly payer. Both currently yield in the neighborhood of 4%.

Utilizing a compound interest calculator, like this one, we can easily run simulations comparing monthly interest accrual and reinvestment to only quarterly reinvestment. Assuming an initial purchase of $10,000, a holding period of 15 years, and a dividend yield of 4%, let's calculate the results. Keep in mind that this calculation does not take into account dividend growth or reinvestment yield fluctuation.

Realty Income: $18203.02

Digital Realty: $18166.97

Variance: $36.05 (0.36%)

After 15 years, our monthly payer, in nominal terms, represents a whopping $36.05 total return advantage over the quarterly payer. In percentage terms, that's about .36%, not even 50 basis points. If you start with a higher initial investment, you would benefit in terms of nominal gains, but the percentage variance remains the same.

In the real world, thinking historically, both companies would exhibit dividend growth, reinvestment yield points would vary, and the variance would likely be wider. How much? That would depend on how much growth were to occur.

As one ascends the yield pyramid, frequency compounding variance has a much more noticeable impact. Let's pit one of Eaton Vance's option-income funds that yield in the 9.5% neighborhood with monthly pay against a 9.5% yielding fund that compounds quarterly. We'll assume 15 years again.

Eaton Vance Fund: $41345.93

Other Fund: $40891.67

Variance: $454.26 (4.54%)

In this case, the variance represents 4.54% of our initial $10,000 investment. Of course, again, we're simulating a situation where yield remains constant over the life of the investment, not a realistic scenario in terms of an equity. Although, in this case, we're not likely to see much distribution growth, if any, and might actually be risking a decline at some point over the 15-year life.

Looking At Variance Through The Yield On Cost (YOC) Lens

Yield on cost, or YOC, is a tracking metric that evaluates dividend growth over time. For example, if you purchase a stock at an initial yield of 4% and the company grows its dividend an average of 6.5% annually for 15 years, you would generate 10.29% YOC. In this case, we assume the unlikely scenario of no reinvestment and no additional purchases. YOC can still be tracked with reinvestment and share accumulation, but it becomes a bit more difficult.

This is also a helpful method of evaluating quarterly/monthly variance inclusive of a growth assumption.

If we start reinvestment on the same scenario above at a 4% yield point each time, on a quarterly basis, our YOC would grow to 10.52 percent. On a monthly basis, it would grow to 10.58 percent. Assuming a $10,000 investment in all three cases (no reinvestment, quarterly, monthly), we would generate $1029, $1052, and $1058, respectively, in annualized dividend income by the end of 15 years. In our first year, we would have seen about $400 of income in all 3 cases.

Frequency with 4% Starting Yield 6.5% Growth YOC After 15 Years
Annual Bump No Reinvestment 10.29%
Quarterly Reinvestment 10.52%
Monthly Reinvestment 10.58%
Daily Reinvestment 10.60%

This shows that reinvestment marginal benefit from quarterly to monthly pay (.06%) is much less than the benefit from no reinvestment to quarterly reinvestment (.13%). I added a column for daily reinvestment to further illustrate the fact.

The shortfall in this simple calculation is that it does not take into account all of the income received over the life of the investment. When you add all the nominal variance, you come up with something a bit more bottom line meaningful.

If we consider double-digit yield on cost attainment, it also shows that investing in robust dividend growth situations can prove more cash flow lucrative over the long term than investing in no growth high yield. The shortfall there is that it will take even longer to eclipse total income received.

Weighing Valuation, Growth Rate, And Yield

At the end of the day, investors need to weigh what is most important to them and not be overly optimistic with return expectations and projections.

So Realty Income might appeal to conservative types that prize cash flow durability more than a higher level of dividend growth. The monthly income is nice, but I'd opine that should be a subordinate consideration. More important would be whether its valuation, growth rate, and even starting yield, make it a more attractive option relative to other REITs or income producers in today's market. In a continuing era of ZIRP, it may be justifiable.

One might assume that Digital Realty will grow faster than O, but it could similarly be argued that DLR is more susceptible to recessionary problems or technological advancement. Owning a mix of security types from similar spaces can help diversify overall cash flow risk, although arguably it may slow overall portfolio income growth - if that is a prime consideration.

For those reinvesting, unless you are looking at an extremely long time frame or extremely large sums of money, the marginal benefit of a monthly payer versus a quarterly payer is not particularly compelling in my opinion. If you opt for a monthly payer with a low growth rate versus a quarterly payer with a high growth rate, you will probably be leaving total return money on the table over the long term. But you may still be able to realize more income.

Starter Portfolio For Monthly Dividend Investors

Here are some monthly payers with attractive fundamentals worth considering right now.

  • EPR Properties (NYSE:EPR): EPR is an owner of movie theaters, ski slopes, entertainment centers, and also charter schools. Operating in a triple net manner, the stock currently yields around 6% and at a significant FFO discount to Realty Income. While the model is concentrated, management continues to grow the business at a consistent clip. A $10,000 investment currently yields $50 a month.

  • Main Street Capital (NYSE:MAIN): One of the few BDCs that trades above NAV today, MAIN boasts an internal management structure that provides better shareholder alignment in a space where external structures and misalignment have proven near-term destructive to investor returns. The premium to NAV price and lower yield (7%) compared to peers is reflective of higher allocation to equity investments and a solid growth track record. A $10,000 investment currently yields about $58 a month.

  • Eaton Vance Tax Managed Diversified Equity Income (NYSE:ETY): One of many diversified funds offered by Eaton Vance that employ various income generating option techniques. Specifically, ETY utilizes virtually all of the portfolio with near-the-money, short dated expirations. A $10,000 investment currently yields about $80 a month in mostly tax advantaged income - "good" ROC. The fund currently trades at a 7% discount, with a little better than 1% annualized fee.

Disclosure: I am/we are long EPR, ETY, MAIN.

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.

Additional disclosure: Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.