Dividend Growth Investing: Can Conversion From Price Growth Work?

Includes: CVX, HRL, IBM, JNJ, KO, MO, PG, T, XOM
by: DivEngineer

Dividend Growth Investing discussions often include disagreements over the possible success in buying growth stocks early in life and converting to income stocks later.

An experiment is created to test this idea.

A comparison is made over 19 years and 10 stocks versus QQQ.

It is not unusual to see discussions pop up in article comments about whether Dividend Growth Investing (DGI) is something that a growth investor can easily and cleanly switch to in time for retirement. The discussions are often spirited with many that are absolutely convinced that there really no path for a growth investor to change midstream to dividend growth. Usually this is due to how a switch would occur. For example, do not wait until the day of your retirement to suddenly decide to sell everything and buy income stocks because it could be in the middle of a recession that you had not planned on. I started as a growth investor and switched about 10 years ago. I started the switch by following the "Dogs Of The Dow" philosophy. This gave me an understanding of how dividends could positively impact portfolios. When I see others argue that switching just does not work, I have experience that disagrees with that statement.

So the question here is whether an investor can start out investing by buying growth stocks and then later convert to a dividend growth portfolio and whether this is better or worse than just starting out as a dividend growth investor and doing it for the long haul. I will attempt to answer this by comparing a $10,000 purchase on March 10, 1999 of QQQ versus 10 stocks of my selection. The reason for March 10th is that it is the first day QQQ was available for purchase. The 10 stocks were chosen based on what I considered to be a reasonable list of typical DGI stocks for the time frame indicated. It can and probably will be argued whether these are typical but I had to start somewhere. From the purchase point until January 31, 2019, all dividends will be reinvested. On January 31st, QQQ will be sold and the proceeds will be used to purchase each stock. The amount of income that is gained by that purchase will then be compared to the income that the stock is producing after 19 years of compounded dividend growth. As a side result we will also know the value of those two paths over that time frame. The idea is to see which of the two ways produce the most income on January 31, 2019.

Note that while some readers will consider this a problem with the comparison, the effect of taxes and transaction fees will be assumed to be zero for this article. The complexity of each person's tax situation would go far beyond the scope I intended and would be unimportant if this were done inside an IRA portfolio. Transaction fees would likely be minimal since dividend reinvestment is usually free leaving only the first and last transactions as costs making them unlikely to affect the conclusions of the article.

The following stocks will be used for the comparison:

  • Altria (MO)
  • Coca-Cola (KO)
  • Chevron (CVX)
  • Procter & Gamble (PG)
  • Johnson & Johnson (JNJ)
  • International Business Machines (IBM)
  • Exxon Mobil (XOM)
  • AT&T (T)
  • Hormel (HRL)

This chart shows the starting price, the number of shares initially bought, the final price and the number of shares owned after 19 years of dividend reinvestment.

The idea of the article is to buy QQQ, allow it to grow for 19 years, sell it and use the proceeds to purchase each stock and see how the income produced by that purchase compares to the income of just purchasing the stock and growing the income via dividend reinvestment. The charts below give the final value of each based on the price on January 31, 2019 and the comparison of the income generated by the conversion from QQQ to the stock versus the income generated by the stock itself.

Altria had a relatively high yield (>4%) over the entire 19 years. Couple that with a pretty good dividend growth rate that averaged around 9% and a price that started out reasonably low compared to the following 19 years and you get a stock that grew its value and income quite well. The end value of MO is significantly higher than QQQ and that translates into nearly twice the income when liquidating QQQ and buying MO leaving MO with a clear win against QQQ in both total return and income.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 753.84 shares of MO @ $49.35.

Conversion Income: $2,412.29 (753.84 * $3.20 dividend)

Final value of MO as of 1/31/19: $71,919.91 (1457.34 shares @ $49.35)

MO Income: $4,663.50 (1,457.34 shares * $3.20 dividend)

MO Yield On Cost: 46.64%

MO Yield: Initial 4.37%, Final 6.48%, Average 5.07%, Growth Average 9.34%

Coca-Cola is a perennial favorite for dividend growth stock investors. While it has made people good money over time, it does not compare well against QQQ here. If you had purchased QQQ and sold it to purchase KO, you would have had almost $380 more per year in income than if you had bought KO and reinvested for the 19 years. Part of KO's issue is that it started out with a low yield of 1.02%. So even with many years of double-digit dividend growth, it was impossible to overcome the slow start which leaves KO with less total return and income compared to QQQ.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 772.95 shares of KO @ $48.13.

Conversion Income: $1,205.80 (772.95 * $1.56 dividend)

Final value of KO as of 1/31/19: $25,492.64 (529.66 shares @ $48.13)

KO Income: $826.27 (529.66 shares * $1.56 dividend)

KO Yield On Cost: 8.26%

KO Yield: Initial 1.02%, Final 3.14%, Average 2.50%, Growth Average 8.28%

Chevron fares significantly better than KO. It starts with a healthy 2.99% yield and has several years of solid dividend growth to help. It also has a solid price increase over time which limits the number of shares that QQQ converts to thereby limiting the conversion income. The total return and income comparison is a clear win for CVX.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 324.48 shares of CVX @ $114.65.

Conversion Income: $1,453.69 (324.48 * $1.12 dividend)

Final value of CVX as of 1/31/19: $55,246.53 (481.87 shares @ $114.65)

CVX Income: $2,158.78 (481.87 shares * $4.48 dividend)

CVX Yield On Cost: 21.59%

CVX Yield: Initial 2.99%, Final 3.91%, Avg 3.44%, Growth Average 6.39%

Procter & Gamble is another stock that I would consider to be a stereotypical dividend growth stock. It wound up in a virtual tie with QQQ for income and slightly behind in total return. PG started with a yield of 1.24% and grew at a rate of around 10% which was not quite enough to overcome the low starting yield.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 385.63 shares of PG @ $96.47.

Conversion Income: $1,106.30 (385.63 * $2.8688 dividend)

Final value of PG as of 1/31/19: $35,121.30 (364.06 shares @ $96.47)

PG Income: $1,044.43 (364.06 shares * $ 2.8688 dividend)

PG Yield On Cost: 10.44%

PG Yield: Initial 1.24%, Final 3.14%, Avg 2.48%, Growth Average 7.07%

Johnson & Johnson is probably one of everyone's favorites. It has been a popular stock for a long time. The yield for JNJ starts out at a low 1.27% but overcomes that with a solid growth rate in the middle to upper teens for the first 8 years before settling into the mid to upper single digits for the remainder of the 19 years. But this was enough to catch and significantly pass QQQ in income and total return on the conversion day.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 279.55 shares of JNJ @ $133.08.

Conversion Income: $1,006.37 (279.55 * $3.60 dividend)

Final value of JNJ as of 1/31/19: $49,800.80 (374.22 shares @ $133.08)

JNJ Income: $1,347.18 (374.22 shares * $3.60 dividend)

JNJ Yield On Cost: 13.47%

JNJ Yield: Initial 1.27%, Final 2.71%, Avg 2.41%, Growth Average 10.37%

International Business Machines is a stock that's not as popular as the others we have discussed so far. That does not mean it is not owned by a lot of people, it is just not one you will have come up in as many conversations about stocks. For this comparison, the early yield for IBM was very low at 0.48%. The dividend growth rate was admirable in the middle of the period used and solid at upper single digits for most of the rest of the time but it was just not enough to catch up to the very slow start the yield provided. This led to a solid win in total return and income by QQQ when compared to IBM.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 277.42 shares of IBM @ $134.10.

Conversion Income: $1,742.20 (277.42 * $6.28 dividend)

Final value of IBM as of 1/31/19: $21,051.10 (156.98 shares @ $134.10)

IBM Income: $985.84 (156.98 shares * $6.28 dividend)

IBM Yield On Cost: 9.86%

IBM Yield: Initial 0.53%, Final 4.68%, Avg 1.78%, Growth Average 14.94%

Exxon Mobil is another popular stock similar to Chevron. Since they are both in the oil and gas sector, that would seem to make sense. XOM has a low but solid starting yield of 2.3% and has some good dividend growth spurts along with some solid growth years. But the growth was only enough to get XOM to a virtual tie with QQQ in income and a close loss in total return.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 455.29 shares of XOM @ $73.28.

Conversion Income: $1,493.36 (455.29 * $3.28 dividend)

Final value of XOM as of 1/31/19: $34,202.48 (466.74 shares @ $73.28)

XOM Income: $1,530.90 (466.74 shares * $3.28 dividend)

XOM Yield On Cost: 15.31%

XOM Yield: Initial 2.31%, Final 4.01%, Avg 2.57%, Growth Average 9.27%

AT&T is a popular dividend stock in part due to its high yield. But that yield has not always been high. In fact, it started this comparison with a low starting yield of 1.88%. Its price growth over the period was actually negative which combined with dividend growth moved the yield to a high 6.79% by the end of the 19 years. That low starting yield and low dividend growth combined to make T a significant loser to QQQ in this comparison.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 1237.59 shares of T @ $30.06.

Conversion Income: $2,524.69 ( 1237.59 * $2.04 dividend)

Final value of T as of 1/31/19: $14,651.13 (487.40 shares @ $30.06)

T Income: $994.29 (487.40 shares * $2.04 dividend)

T Yield On Cost: 9.94%

T Yield: Initial 1.88%, Final 6.79%, Avg 4.62%, Growth Average 4.19%

Hormel is what I would call a background dividend stock. It is popular in some circles but it is not one that will come to most people's mind when asked for a list of dividend stocks. But as the numbers show, it has given a nice return to anyone that has owned it for a long time. It accumulated the highest value after 19 years by far. Its income was 2nd only to MO. It did this while starting and finishing with a low yield but with a nice growth rate. Its price appreciated more than any other stock by far. This allowed it to handily beat QQQ in total return and income.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 879.06 shares of HRL @ $42.32.

Conversion Income: $738.41 ( 879.06 * $0.84 dividend)

Final value of HRL as of 1/31/19: $130,339.56 (3079.86 shares @ $42.32)

HRL Income: $2587.08 (3079.86 shares * $0.84 dividend)

HRL Yield On Cost: 25.87%

HRL Yield: Initial 1.77%, Final 1.82%, Avg 1.75%, Growth Average 12.50%

3M is a well-known stock both in the growth and income world. It has been a popular addition to many portfolios over the years. Its yield was pretty consistent throughout the period which coupled with a solid growth rate and the 2nd highest price appreciation allowed it to easily beat QQQ in both income and total return.

Final value of QQQ as of 1/31/19: $37,202.16 (221.23 shares @ $168.16)

QQQ Dividends: Average Yield = 0.74%

Conversion: 185.73 shares of MMM @ $200.30.

Conversion Income: $1,010.38 (185.73 * $5.44 dividend)

Final value of MMM as of 1/31/19: $82,530.64 (412.04 shares @ $200.30)

MMM Income: $2,241.47 (412.04 shares * $5.44 dividend)

MMM Yield On Cost: 22.41%

MMM Yield: Initial 2.87%, Final 2.71%, Avg 2.33%, Growth Average 8.10%



Total Income for QQQ: $14,693.49

Total Income for DGI stocks: $18,379.74


While total return is not something that most dividend growth investors care about, it seems that it is a requirement for some. Looking at the total return indicates that 5 out of the 10 stocks produced a total return higher than just owning QQQ and 2 of the other 5 are in a virtual tie with it. This indicates that depending on the stocks owned, there is a reasonable chance that dividend growth stocks will do as well in total return as owning something like QQQ. There obviously are other growth stocks that will do better but I used QQQ as a reasonable facsimile for a typical growth stock. For example, comparing against AMZN would show that all of the 10 stocks used here would have a significantly lower total return.

Looking at this based on income as the vast majority of dividend growth investors will, it is clear that starting from a low yield is very difficult to recover from. JNJ and HRL were the only initial yields below 2% that recovered and had more income than QQQ and of the two, only HRL beat on income easily. The lower incomes all had initial yields below 2% and could not overcome the slow start even with similar or higher dividend growths than the other stocks.

IBM had the highest dividend growth but was one of the lowest incomes due to the initial yield of 0.53%. The conclusion here is that you should generally avoid stocks with low yields even if the growth is relatively high if you want the most income you can get in a reasonable amount of time. Keep this in mind when using Chowder numbers. Unless you have a very long investment period, 1% yield and 14% growth will not do as well as 6% yield with 9% growth even though the Chowder numbers are the same.

While buying QQQ did result in higher income for 4 of the 10 cases, it had less income as a total over all 10 stocks. Because of the income disparity and the 6 out 10 income wins, I am declaring that dividend growth stocks won the comparison and that this data set indicates that even forgetting the issues possible in transitioning, it may not be wise from an income aspect to go the switch route. But it is arguable how significant of a win it is. A 6-4 win ratio is not very overwhelming and if you take away the large income for MO, it is almost even. Nevertheless, I call the dividend growth choice the winner in a close one.

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Note: All data used in scoring is current as of the date when the article was written. Some of it, such as prices, have likely changed by the time the article is actually published.

Disclaimer: None of my articles including this one are investment advice of any kind. The purpose here is to define a system and see how it might work. If you like what you see and decide to invest based on it, do you own due diligence to make sure you are spending money in a way suitable for you. I am neither an investment professional nor plan to be. This is an academic exercise for the benefit of all involved. I hope all readers find benefit but there are no guarantees of success or performance in any way with what is outlined in any article I write.

Disclosure: I am/we are long T, MO, MMM. 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.