The Stages Of Dividend Growth

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Includes: JNJ, KO, PG
by: Robert Allan Schwartz
Summary

Before retirement, investors might invest for a higher dividend growth rate.

After retirement, investors only need to beat inflation.

This could cause a shift in which companies you own.

The First Stage - Getting To Retirement

Suppose your overall portfolio income today is (let's say) $5,000/year.

Suppose you calculate that you can retire when your overall portfolio income reaches (let's say) $50,000/year.

How many years until you reach your goal?

What dividend growth rate do you need?

This chart demonstrates the relationship between dividend growth rate and the number of years to reach the goal.

The sooner you want to reach your goal, the higher the dividend growth rate you need.

But the higher the dividend growth rate you need, the riskier it is, the harder it is to SWAN (sleep well at night), and the harder it is to find companies that meet that requirement. Each investor must find their own balance point.

How do you find companies that will have a specific dividend growth rate?

I can't see the future, but if you believe (as I do) that the companies that have already "done that" are more likely to "do that" again, then the question is, how do you find companies that have had a specific dividend growth rate?

If you seek companies that raise their dividend by X% (or more) for Y (or more) consecutive years, then this chart answers that question. The chart clearly demonstrates that the higher the dividend growth rate, the shorter the streak, and the fewer the number of companies that have done that.

You might be willing to relax the requirement that a company raise its dividend by that growth rate "each and every year", and settle instead for a company that raises its dividend by that growth rate "on average".

The number you are looking for is called the CAGR (compound annual growth rate).

CAGR is measured over an interval of time. Which interval should you use?

Suppose you calculate you are N years away from retirement. Then you might seek companies whose CAGR over the last N years matches the CAGR you need over the next N years.

If you seek companies that have a specific dividend CAGR over a specific interval, then this chart answers that question. Click on a year, and it will take you to a page like this.

You will see a list of companies, sorted by dividend CAGR.

(If you see a CAGR of -99, it means the CAGR could not be computed for that company for that interval. Often that happens because that company's dividend history is shorter than that interval.)

You will also notice numbers called "bumpiness". Just as some roads are smooth and others are very bumpy, some dividend growth companies offer smooth dividend growth, and others offer very bumpy dividend growth.

This article explains the concept of bumpiness.

How bumpy a road can you tolerate?

If you're the kind of investor who likes Procter & Gamble (NYSE:PG) (bumpiness 3), Johnson & Johnson (NYSE:JNJ) (bumpiness 4), and Coca-Cola (NYSE:KO) (bumpiness 2), then you could search for companies with similar low bumpiness. Or you might be comfortable with higher bumpiness.

If you seek companies that have a specific dividend bumpiness over a specific interval, then this chart answers that question. Click on a year, and it will take you to a page like this.

You will see a list of companies, sorted by dividend bumpiness.

The Second Stage - In Retirement

Congratulations! You have achieved your personal investing goals.

You own a portfolio which pays you (most or all of) the income you need to be retired and stay retired.

How does that affect the amount of dividend growth that you need?

The biggest danger to a retired or fixed-income investor is inflation. Inflation erodes the purchasing power of your dollars, so you need more dollars to buy the same goods and services. The government measures inflation using a "basket" of goods and services that the government believes the "average" person will buy, but your personal "basket" is likely to be different, so the rate of inflation that you experience will likely be different from the government's.

The way to prevent the erosion of purchasing power is for your income to grow each year by at least as much as the rate of inflation.

As inflation has averaged approximately 3% from 1926 to the present (link), your dividend growth rate in retirement is likely to be smaller than your dividend growth rate before retirement.

Before you retire, your goal might be to reach a certain level of income, as fast (and as safely) as you can, so you choose companies with a high(er) dividend growth rate.

After you retire, your goal is different - your goal is to prevent inflation from eroding your purchasing power, so you choose companies with enough dividend growth to outpace inflation.

This difference is significant. It might alter the composition of your portfolio. It makes sense that if your goals change, then your strategies and your tactics (and which companies you own, and why) change.

When the rate of dividend growth becomes less important, and the current yield (and therefore current income) becomes more important, it might benefit you to sell some of your positions and buy different ones instead.

For example, before retirement you might have owned $10,000 worth of shares in (let's say) UNH, whose dividend CAGR from 2000 to 2017 was 47.803% and whose current yield is 1.3%, so you would be receiving $130/year in income; when you reach retirement, you might sell those shares and buy $10,000 worth of shares in (let's say) T, whose dividend CAGR from 2000 to 2017 was 4.007% and whose current yield is 5.69%, so you would be receiving $569/year in income. Your income went up!

This "phase shift" happened to me as I was transitioning into retirement. I sold my high(er) dividend growers and used the cash to buy high(er) dividend payers (i.e. high(er) current yielders), because I needed the dividend growth less but I needed the current income more.

Conclusion

Before retirement, investors might prefer high(er) dividend growth with low(er) current yields, but in retirement, investors might prefer high(er) current yields with low(er) dividend growth. In retirement, the only dividend growth you need is enough to offset the erosion of purchasing power caused by inflation.

Disclosure: I am/we are long T. 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.