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# Dividend Growth Rates: Using The Past To Estimate The Future

Apr. 22, 2012 6:35 AM ETABT, CVX, JNJ, KO, LOW, MCD, PEP, PG, T, WMT91 Comments

Dividend growth investing involves buying the stocks of companies that not only pay dividends, but consistently increase their dividends over time. Many dividend growth investors look for companies with dividend growth rates, or DGRs, that exceed the rate of inflation and appear to be sustainable going forward. One approach to screening for dividend growth stocks involves calculating a future yield on cost, or YOC, based on a stock's current yield and its past DGR (often the 5- or 10-year DGR). The formula for YOC is:

YOC after N years = Yield * (1 + DGR/100) ^ N

For example, if a stock has a current yield of 4% and a DGR of 10%, then the YOC after 10 years would be: YOC = 4 * (1 + 10/100) ^ 10 = 10.4%. Future YOC can be used as a screening criterion if an investor looks for dividend growth stocks that may produce a certain minimum YOC after a certain time period. In previous articles on Seeking Alpha, there has been a focus on the criterion of achieving a 10% YOC after 10 years:

A critical assumption underlying the use of future YOC in stock screening is that the past DGR for a company is

I am a 40-year-old investor and a professor at a university. I have been following a value-oriented dividend growth investing strategy since 2012. I have written occasional reviews on Seeking Alpha about my portfolio and investing progress.

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Thanks for posting that correlation plot! very interesting. I don't suppose you'd be willing to share the raw data? I'm interested in the tickers forthe unspecified companies in the correlation plot, particularly the ones that fall on the unity line at 10-15%. Talk about DG consistency! If not, I understand.

I was also interested in what the regression line looks like when weighted by market cap, and also if DG < 5% are omitted. Oh and the slopes and R^2's would be cool too.

Thanks again for the great work here.
Ernie7: Thanks for your comment. I have posted the data on my Instablog:

http://seekingalpha.co...
Weak form of effective market hypothesis (EMH and hypothesis is very good word here) says that stock prices are unpredictable. What is about dividends?

Data for main indexes (see figs in http://seekingalpha.co...) indicate on quite random DCR behavior, so might be weak EMH is also valid for DCR. It seems interesting also that Dividend Champions had slow down of dividend grow rate in second decade to compare with the first one. In contrast dividends of S&P500 (and many Dividend Champions are in this index) increased faster in the second decade - about 29% between 1991 and 2001 and about 69% between 2001 and 2011. The reasons might be popularity of stocks buybacks in the first decade and some special dividends that happens between 1981 and 1991 (when S&P500 dividends increased ~ 84%) and in first decade of this century. Are these reasons caused the discripancy?

A stock market reverts to the mean in a long run (BTW really WHY /I didn't see a good explanation except for bubbles/?). Does DCR (dividend change rate) makes the same?

SDS
Thanks for stat details
Dividend Growth Machine,
You wrote: "the decrease is almost statistically significant"
Method, numbers?
SDS
Paired samples t-test: t(56) = 1.998, p = .051 (two-tailed)

I used alpha = .05 as my criterion for statistical significance; therefore, any result with p < .05 was labeled as significant.
Dividend Growth Machine,
Good article although survival bias is embedded in your analysis. Analysis of initial Dividend champions (http://bit.ly/ve4T5H) gives less "rose" results. Some companies had negative DGR (so I prefer to use DCR=dividends change rate), analysis of DCR for S&P500 and DJ-Euro50 will be given in second part of Single Factor Dividend Income Model /see my instablog/.
SDS
SDS: Thanks for your comment. I agree that my analysis is subject to survivorship bias, hence my acknowledgment of it as a limitation.
Okay, time to stir up some feathers! My Dread Sox are well, dreadful ... and I've gotta release some of that frustration. Ha!

DGM mentioned diworsification up above. I'll have to go back and re-read Lynch's book because for now, I don't know what that means.

I own 50 companies.

I own KMP, KMR, KMI, EPD and MMP. Does adding any one of those to my account make my portfolio worse if I had just held one of them initially?

I owned KO initially. Did adding PEP make my portfolio worse?

T and VZ? ... CVX and COP? ... ABT and JNJ? ... MO and PM?

I own every company listed above. Would I be better off only holding one of each?

James O'Shaughnessy (JOS) who wrote the book "What Works On Wall Street," wrote a follow up book titled, "How To Retire Rich." In this book, JOS says that in order for the strategies to work, one must own 25-50 companies. He said that most of the studies he performed were based on 50 stock portfolios. He said that owning this many companies is what made the strategies work.

Now get this! He anticipated those who asked, how can I keep up with that many companies? He doesn't want you monitoring your holdings that closely. He wants to protect you from your own impulses.

There is nothing in an annual report or a news article written today that is going to get me to sell one of those companies listed above. They met my long term requirements to make it into my portfolio and I know from time to time that bad news is going to hit them.

JNJ recently, with their recalls, are a good example. A lot of people sold because of it and I added to my position. Isn't the best time to buy, often when the company is struggling, as long as the company is financially sound?

JOS goes on to say that a stock-to-stock approach wreaks havoc with our ability to buy stocks successfully, since it virtually guarantees that we will base our decisions on emotions and short-term thinking.

Say what? ... Wait a minute! ... Hold the phone! ... I think I've been there, done that! ... (Hanging my head in shame.)

The law of numbers protects you from yourself. It helps to take the emotion out of the equation.

JOS says a large number of holdings forces you to focus on the strategy that helped you choose your companies in the first place, as opposed to the day to day monitoring of each company.

It's the strategy where the focus should be. And if the strategy was designed for the long term, then I focus on the long term. It's why I continue to hold companies like JNJ, EXC and SYY, companies who still contribute to my overall plan, but their share price isn't reaching for the sky yet. I can afford to be patient with these companies due to the large number of companies that I hold.

He then says to hold an annual review to determine who continues to meet your strategy and who doesn't.

Someone I respect very much held an annual review last year and decided SHW didn't belong in his portfolio anymore. This person wishes to hold a more concentrated portfolio. It's because of this concentration that SHW got the boot. If this person believed in holding more positions, he could have been in a position to be more patient. If he were more patient, he would have benefited from an incredible price move in SHW over the past year.

http://bit.ly/JvL9qp

Now don't get me wrong. I'm not saying he was wrong to get rid of SHW. The decision that he made, given the data, given his knowledge and experience and the urgency to fix the problem, was the right one - even if the outcome might suggest otherwise.

I think if one were to embrace the concept of a larger number of holdings, as JOS suggests we should, then companies like SHW are in a position to help us going forward.

Okay, I've said enough for now. If I said anymore it would become an article and I don't have any interest in being an author. Ha!

Percy, get me outta here! Time for a cold one!
Chowder -- "There you go again"...(Ron Reagan to Jimmy Carter -- 1980 debates)

If I didn't know you (much) better, I might think you are genuinely confused and in need of advice from 900 of your best friends(?)...but as I do know you better--it must be a boring day for you!

OK, I'll play...Mr. Chowder, you nincompoop!...you obviously don't know what you are doing!...to this immediately...put your 50 stocks in alpha order by symbol, and sell at-the-market first thing tomorrow, every 3rd symbol, and also the last 2, so your total holdings number 18.

I have completed your personal star chart, and 18 is your perfect number. I guarantee you long life and total happiness with these 18 stocks...BTW, be sure to let me know what they are, and I will buy them also as payment for my valuable services.
Chowder: There are two common interpretations of the term "diworsification:"

1. A company needlessly diversifying itself by acquiring or expanding into businesses that bear little or no relation to its primary business, with negative effects on the company's overall operating results. This interpretation is what I alluded to in my earlier comment and it is how Peter Lynch defined the term in One Up On Wall Street.

2. An investor diversifying his portfolio by adding more and more companies that are of progressively lower quality (because one would presumably try to buy the highest quality companies first), resulting in a portfolio that is weaker than a more concentrated one. This interpretation is what many investors mistakenly attribute to Lynch, but I do not recall him applying the term to portfolio diversification. (If he did, I would appreciate someone citing a reference.)

Personally, I don't think portfolio diversification should be considered diworsification, at least not in general. There are many ways to diversify a portfolio and I have yet to see any compelling evidence that diversification in and of itself results in a weaker portfolio. It all depends on how you do it. I think you've provided good justification for your level of diversification. Indeed, your views on diversification are quite similar to mine.

I've been thinking about writing an article on diversification, although I'm a bit hesitant to address such a controversial issue. ;)
One problem with assuming that a person is hurting their portfolio by adding more companies is the simple fact that such a conclusion assumes that they already owned the best, in general and/or by industry. So it would be true if you already own Coke and then add Sludgewater Cola. But it would be silly if you first owned Sludgewater to say that adding Coke could make your portfolio worse.
DGM,
Great article and appropriately an Editor's Pick! I think you've confirmed my suspicion that there's somewhat of a natural erosion in the high DGRs over the years, albeit a small one. But what's especially encouraging is that even the low DGRs still tend to keep investors ahead of inflation, which suggests that it is possible to live on a growing income stream.
David -- Very well said.

[DGM's work belongs in a SA library of 'best investing articles' so that it would be immediately available for to present and future members]
David: Thanks, I appreciate your feedback. I agree that it is encouraging to see that even the low DGRs tended to beat inflation.
richjoy: You are too kind. :)
c
Excellent article - like so many I find here on SA.

My experience is like that of many others I find commenting here - Started with mutual funds, graduated to stocks, didn't really have a strategy except to hope for capital gains. Then I found "Dividends Don't Lie" by Geraldine Weiss, and began to have a focus.

But instead of YOC, I have been using what I call "Cumulative Yield on Cost" - which is the sum of dividends paid over a period of years per dollar of initial cost, which seems more indicative of what many of us are aiming for. And I'm wondering what others see as the pluses and minuses of such a cumulative statistic.
charlie1919: Thanks for your comment. I also keep track of the cumulative dividends received from each of my stocks. One could interpret your statistic as a "payback percentage" -- how much of your original investment has been paid back in the form of dividends. Once you get to 100%, your entire original investment has been recouped in dividends alone, which would be a nice milestone.
charlie -- I keep a spreadsheet of my annual dividend income.

For each holding, (left to right) I have columns for total \$ received in all previous years, previous yr per shr dividend, latest dividend rate for present year, a listing for each of the 12 months, and a running total column. I update the spreadsheet as dividends are received (including one this morning).

At the bottom, rows sums are as follows:
Total 2012 by Month
Total 2012 YTD
Month 2012 VS 2011
Cum Diff 2012 VS 2011
Total 2011 by Month
Total 2011 YTD

If you are still reading, you can see that I take dividends seriously.

However, I also keep this data separate from my monitoring activity, so that (to the best of my ability) I do not allow this data to influence my assessment of how news and events may affect the future earnings stream of my holdings.
David Van Knapp
23 Apr. 2012
rich,

Your last paragraph is really impressive, I hope people kept reading to it and comprehended it. To me, it sounds like a great way to separate what a stock has accomplished for you in the past from the cold hard business decisions you need to make in the present to keep your investing business in tip-top shape.

It's actually easier to run an investing business than a hardware store. Stocks don't have feelings. You can hire and fire them at will. It's not like you feel an obligation to "Poor Old Charlie" based on his years of loyal service to you. If a stock fails to meet your current criteria for ownership--which certainly include consideration of its history (as a clue to the future) but also includes other factors pertaining to the future--you can fire it without feeling bad. Emotions play only the role that you allow them to play, no more and no less.

Dave
Count me as one who doesn't focus a whole lot on payout ratios. I think DVK is the man in charge of this camp and I happen to follow along.

I'm of the opinion that the company knows best what their payout ratio should be. I don't have any inside knowledge. I have to judge a management team by their historical performance, their resume sort to speak.

I do know that some companies plan for high payout ratios, think MO for example.

I see where some people are concerned that PG's payout ratio is getting up there. Well, PG didn't have to give a 7% raise in the dividend, but they did. They could have kept a lower payout ratio and still kept their dividend increase streak alive.

I took it as a sign of strength, based on their 56 years of history with regard to dividend increases, and assumed they know what they are doing.

Maybe a rising payout ratio is a sign of weakness, I don't know. What I do know is that I invest in these companies expecting them to share the profits with me. If they want to give me more, I'll take it. If at a later date they no longer can continue, I'll fire them. I'll get to keep what profits they shared prior to that time though, and that's what I care about.

I'm not saying I totally ignore payout ratios, it's just not a focus.
Chowder: Good comment. I agree that a company's dividend policy likely includes an assessment of what payout ratio is ideal for that company, which may be lower or higher than the ideal of another company. Some companies are comfortable with high payout ratios, whereas others strive to be more conservative. For example, a company in a cyclical industry might target a modest payout ratio (e.g., 30%) so that it doesn't have to freeze or cut its dividend if its earnings take a hit due to poor economic conditions.

I would consider a rising payout ratio to be a potential sign of weakness if it occurs without any earnings growth over a period of several years. In addition, sharp increases in the payout ratio to very high levels (e.g., 90%) for a non-utility company would likely warrant investigation for potential problems.

However, I would not consider an increase in the payout ratio from, say, 20% to 30% to be a sign of weakness. It could simply reflect management deciding to be more generous to shareholders. Indeed, I have read press releases about dividend increases in which management has expressly indicated that it is targeting a higher payout ratio. That's one reason why I consider a low payout ratio to be a plus: It gives management plenty of room to be more generous down the road.
Chowder and DGM -- I appreciate what both of you have expressed about payout ratios and management's comments...if we can attach one caveat...that it is management's intention to put in a favorable light whatever they have to announce, or answer to analysts questions.

p.s. I recall that the top execs of my former Fortune 100 employer trained its execs in how to reply to questions...I can't believe it is any different elsewhere.
Rich, your story reminds me of my cat. She once ran full-tilt into the patio slider (all glass), because cats don't understand something they can see through but not run through.

After she bounced off, she saw me looking at her. Before I could laugh, she licked her paws, as if to say, "I meant to do that. Didn't I do it beautifully?" :-)
R
Excellent article. Add another voice to the requests for an analysis relative to payout ratios and future DG. It would seem there would be a link, but I'd love to see the data to support it. It may even be a stronger predictor of future DG than past DG.
smithde: Thanks for your comment. I agree that payout ratio might be an important factor to consider in relation to DGR.
DGM, thank you for this excellent article! I appreciate your use of statistics and graphs to illustrate your points and conclusions. Well done!

I am pleased that the universe of DGI companies did as well as it did, in the most challenging decade of investing in years (i.e. the Great Recession). This article will definitely help me sleep well at night!

Thanks,

Robert
Robert: Thanks, I'm glad you liked the article!
David Van Knapp
22 Apr. 2012
DGM,

This is a really good article. Thanks for taking the time to put it together, and for finding ways to work with the available data to produce a meaningful and helpful analysis.

I authored the original 10x10 articles. The intent of them was to illustrate the ways that initial yields and dividend growth rates work in tandem to produce YOCs 10 years out. I tried to supply appropriate and sufficient "warnings" that future DGRs are unknowable, and the farther out you try to predict them, the more likely you are to be wrong. My takeaway from that is that all else equa, higher-yielding stocks are better (up to a danger point of around 9%), since they give you a head start on the eventual dividend stream that you want to achieve.

It has been interesting to see people run with the idea, and to actually use future YOC as a stock selection factor, which is something that I myself don't do. I'm most interested in the rising dividend stream from my portfolio. The individual stocks are building blocks in the portfolio, and there is room for higher-yielding but slower-DGR stocks as well as lower-yielding but higher-DGR stocks. Each has a role to play in achieving the portfolio's overall goals. I do require a minimum initial yield in my own investing (3% or within 10% of that, meaning 2.7% in reality). The requiredminimum yield is one way to defend against apparent high DGRs that don't pan out in the future.

I think you did a really good job of showing that there is a statistically significant relationship between past DGRs and future ones, although of course the absence of banks and other companies that disappeared from CCC during the study period skews the results in favor of showing a tighter relationship than actually happened. I like the proposed adjustment formula for high DGRs at the end of your article; that is very creative.

Dave
Dave: Thanks for your kind words. I like your 10 x 10 articles because they provide an easy way to think about the relationship between yield and DGR. I have also found it interesting how people have taken the idea further and used future YOC in stock selection. In a spreadsheet that includes my watch list, I have a column with an estimated future YOC, but it exists more for the sake of curiosity (i.e., what kind of YOC might I expect after 10 years?) than as a selection criterion.

I aim for a mix of high-yield/low-DGR stocks and low-yield/high-DGR stocks in my portfolio, although I do give a bit more weight to DGR (while being mindful that high past DGRs are not guaranteed). My minimum initial yield is 2% and I prefer DGRs that are above 10%, but those are just two aspects of a multi-faceted stock selection process.

Like you, I consider individual stocks to be building blocks in my portfolio, each contributing in its own way to an overall sustainable and rising dividend income stream.
I think you can create a even more robust analysis by adding one factor to your research: payout rate.

If you take a list of the relatively low DGR firms and then filter for changes in payout rate, you'd have a list of firms that have the financial potential to grow their dividends faster.
huangjin: That is a good observation. I did not have access to historical data concerning payout ratios, but I agree that changes in payout ratios could be very informative.
r
Good analysis.
* The problem with Survivorship Bias mentioned is a really big problem.
* Correlation vs Causation. The impact on growth of earnings should be considered as another regression variable, to see whether any impact is left for past div-growth.

The periods covered started after a crash in 1991 and another crash in 2001, so earnings growth calculated are not really meaningful (4.5% and 13.4% for S&P) But when you normalize the S&P earnings (21, 48, 87 for year ends 1991.2001,2011) you get earnings growth for the periods that are comparable to the dividend growth of the Champions subset.

Period subtotals for 1991-2001, 2001-2011
S&P earnings, 8.6% 6.1%
Champion div growth, 4.7% 5.8%

Note that the dividend growth was lower than earnings. (I could not get the system to format the data box better).
retail -- Having been investing at the time, it would be helpful to insert here the definition of a "stock market crash"...I think we can all agree on something like this:

"A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, economic crisis or the collapse of a long-term speculative bubble."

I offer this definition because the ONLY post-1932 crashes were in 1987 and 2008...thus 1991 was not a crash, it was a very minor and brief recession of 8 months (July 1990 to March 1991). In addition, it did not even immediately follow the crash of 1987, which though very painful, was also so brief that it did not lead to a recession.
retailinvestor: Thanks for your comment. I agree that a more comprehensive analysis would include earnings growth and other factors that might help to determine the main drivers of dividend growth during each time period.
r
I was referring to a crash of earnings -- meaning a stomach churning drop.
I'll second Norman Tweed's comments. In the case of T, which historical stock record would have been used, the original T or SBC Communications?
La Marque: The older dividend data for T (prior to it becoming the current AT&T) are from SBC Communications. I have verified this point using the dividend history from AT&T's website.
Thanks Dividend Growth Machine for a good discussion of future dividend growth rate based on historical dividend growth rate. I think, as you pointed out, that high past dividend growth rate cannot be maintained and dividend growth will fall as current yield increases. It appears to be related to payout ratio. There is a maximum payout that can be attained based on earnings per share growth. Even telecommunications companies which pay yield based on cash flows have a limit.
Norman: Thanks for your comment. One thing I want to examine at some point is the relationship between dividend growth, earnings growth, and payout ratio, with the goal of determining how much of a company's recent dividend growth has been driven by earnings growth vs. an expanding payout ratio.
Mutinousdogs
22 Apr. 2012
DGM, really good article. Thanks for taking the time to do the analysis and for sharing it with us all.
Mutinousdogs: Thanks, I appreciate the feedback!
I am not a statistician, and will leave the technical analysis of DGM's work to those who are fully-qualified to do so.

Absent the unlikely discrediting of DGM's study, I found this article to be of great value to those who have adopted, or might adopt, Dividend Growth Investing as their strategy...in fact it may be groundbreaking, as it seems to solve the obstacles to comparison of DGI over multiple decades--a serious need for anyone contemplating a 30+year strategy--as this work removes some of the 'take this on faith' bias.

That DGM was able to compare the decade 1991-2001 (a period including the longest growth period in US history, and ending in a mild recession), to the decade of the 2001-2011 (a period including the Financial Crisis and Great Recession), should be of importance to every investor in dividend-paying stocks.

The study isn't perfect (nor is any two decade study of a topic as fluid as stocks), but DGM did acknowledge and discuss the study's limitations.

The study is useful to me in that it supports the notion that dividend growth rates tend to have predictive value...though imperfect...and those stocks with high DGRs tend to retain them (perhaps at slightly reduced levels), and those with low DGRs tend to also retain them (perhaps at slightly improved levels).

Stock investing is not science. Sh*t happens (and happens about every 4 or 6 years). Projections are useful, but straight-line projections through 10 years are questionable, which suggests dividend growth rates applied to a group vary around their central tendancy...but for an individual stock, perhaps not so much.

The study can only be interpreted as good news.
________________
As an aside, though all my stocks pay dividends, I own a combination of low and high yields, and low and high DGRs. I do not compute a YOC for my stock purchases (and pay no heed to 10 X 10 tables), as I prefer to weigh heavily the business case (future earnings) for each of my stocks. I also examine their earnings and dividend history through the period of the Great Recession (which is not the same as not buying any stock w/o a history of 5 or 10 years of consecutive dividend increases). Nonetheless, I do track YOC on a total portfolio basis--mostly because it makes me feel good.

I also believe some DGI investors tracking YOC overly focus on YOC when monitoring their stocks, and that focus thus prevents them from making appropriate changes when conditions change...many times I have read comments that XYZ is not performing, but my YOC is a high %, therefore I will not sell it.
Excellent reply Richjoy and a well written article DGM. I have to say I have learned more in 6-7 months since I found SA and in particular these DGI type articles (in addition to books relating to the subject of DGI) than I have in my previous 30 year investment life time. I started investing at age 29 in mutual funds and over the 30 years have made every investment mistake in the book. Here's hoping that since October 2011 I have righted the ship. Better late than never as they say. I hope I never stop learning.
Rich, I came across an analysis I thought you might be interested in reading.

Others may find it interesting as well, but I thought of Rich first! ... Ha!

http://bit.ly/HY7qbo
wedge -- Thank you for that comment.

As I have been investing for about 10 years longer than yourself, consider how many more mistakes you have yet to make ;-)
Thank you for the analysis DGM....I went to your blog & I was reading about your various stock purchases. I wanted to see your whole portfolio, but maybe I could not find the right button to hit. Any industrials or banks in there? Or utilities? I also own HRL since 1996, & PG thru Gillette purchase, and many more. Any value investing, in, say a coal company? ACI is at 52 low...Joe
I prefer BTU to ACI. It has a lower yield but it also has much less debt.
Travel4Yields: Thanks for your comment. Here is a link to my portfolio on my blog:

http://bit.ly/I2k13j

The displayed portfolio is current as of March 31 (I update it at the end of each month), so my recent HRL purchase does not yet appear there.

I do own some industrials (such as ITW and UTX), but I currently do not own any financials, tech, or utilities. Given that I am still in the process of building my portfolio, I do not consider it to be well-diversified at this time. Regarding coal, I do have indirect exposure to it through my railroad stocks (e.g., NSC).
One of the factors I look at when purchasing a given stock is the projected YOC, but I go about it somewhat differently. The formula you supply does not seem to account for reinvested dividends. Is that correct? If so then the actual YOC would be higher, yes?

I could not come up with a formula for this. If you have one one, I would certainly appreciate getting it. ;-} What I did was create a simple spreadsheet that runs the scenario out over 10 years based on current dividend rate and assumed dividend growth rate.

http://bit.ly/I2vcJ7

I would certainly appreciate it if you looked at this and commented on its validity (or lack of).

Thank you
Mutinousdogs
22 Apr. 2012
Eclipsme,
I like your spreadsheet. It is simple and helpful, I think. I used the basic info you set up to play some what if's with different stocks plugging in their present dividend rate and using the DGR projections from this article. I used WMT, MCD and CAH as test cases. I interpolated the past and future DGR's list in the chart to "guess" at a future-future rate. Since each of the companies I used has an historically high DGR you can imagine what the projected YOC is at the end of your ten year holding periods: 19.33%, 33.35% and 23.27% respectively. Of course I could be way off on my target guess for the growth rate, but I did use the data in the article as a basis.
What would be interesting, but it would complicate the spreadsheet considerably is to be able to add purchases along the way and see how the YOC and the overall value is affected. I'm still accumulating shares and since I tend to increase my holdings incrementally it might be useful to try to model that accumulation and see how it looks over the long run. I may try that and see how it works out.