Required Dividend Growth: The Secret Formula

Summary

• We're using this blog to present aspects of our investing philosophy.
• In this article we show you how to compare any dividend stock with another.
• You'll learn how we use the "required growth rate" to pick the best dividend opportunities.

Written by Sam Kovacs

Introduction

So far, Robert & I have made limited use of the blog that Seeking Alpha have given us.

Once in a while we will use it to market our service (we have end of year deals if you're interested).

And on occasion we've showcased some of our tech.But it occurred to me today, that it would also be a great way to showcase small aspects of our investing approach through blog posts, to share with you our unique approach to dividend investing which: improves income potential, reduces risk, and optimizes capital gains.

Typical dividend investing misses out on at least one of these points.

Our approach is effective, because it is fundamentally sound.

Finding the best dividend stocks.

One particular edge we have, is our ability to compare dividend opportunities objectively as a function of both dividend yield and dividend growth.

Certain dividend investors choose to focus on yield, while other choose to focus on dividend growth.

We learned, through talking to thousands of dividend investors throughout the years, that:

• Dividend investors know that yield and growth need to be considered together.
• But that they don't have the tools to objectively analyze these.

Well we decided to change that and build the analytical methods required.

The complexity comes from the fact that the multiple levels of compounding (from dividend reinvestment, and dividend growth)  make it difficult to tell whether a 2% stock growing at 12% per year is better than a 3% stock growing at 9% per year.

Boilerplate approaches like the "Chowder ratio" which sums growth and yield, would tell you that the lower yielding version is better.

The mathematically inclined might point out that with time, the 12% growth would catch up and overtake the higher yield but slower growth.And that would be true. But if you invest in a stock which yields 3% and grows 9%, reinvest the dividends, and also invest in a stock which yields 2% and grows at 12%, for the 41 first years the higher yielding option would generate more income.

Isn't this something you would like to have known when picking stocks?

Robert and I certainly thought so.

The Secret Formula

From a practical perspective, we took a 10 year horizon as a good benchmark.From empirical evidence, we have determined that generating an 8% yield on cash invested, 10 years down the line is attractive. Generating a 10% yield is very attractive.This means that if you invest $10K today, and that in 2031 that position generates $800, then it is attractive. If it generates $1,000 it is very attractive.

From that statement we reverse engineer to calculate the required rate of dividend growth to reach those thresholds.

This gives us a range.

For instance, for a 3% yielding stock, such as Allstate (ALL), the required rate of growth is 7.5% to 10%.Investors can then ask the question: Is ALL able to grow its dividend at those rates?

If the answer is yes (our answer is yes), then ALL is a good income opportunity.

Source. Dividend Freedom Tribe

The graph above shows the yearly income of a $10K investment in Allstate if the dividend grows 10% per year.

So we ran these simulations for effectively stocks of all yields.

The Table Of Required Growth Rates

This gave us a table of required growth rates for each yield, which we are giving to you below.

(Suggestion: Bookmark this page to come back and check the table when picking your next investment)

yield(%)	Required Growth Low (%)	Required Growth High (%)
0.1	55.2	58.7
0.2	44.7	48
0.3	38.9	42
0.4	34.8	37.9
0.5	31.7	34.7
0.6	29.2	32.1
0.7	27	29.9
0.8	25.3	28.2
0.9	23.8	26.6
1	22.3	25.1
1.1	21.1	23.9
1.2	19.9	22.6
1.3	18.9	21.6
1.4	17.9	20.6
1.5	16.9	19.6
1.6	16.1	18.7
1.7	15.3	17.9
1.8	14.5	17.2
1.9	13.8	16.4
2	13.1	15.7
2.1	12.4	15
2.2	11.8	14.4
2.3	11.2	13.8
2.4	10.6	13.2
2.5	10	12.6
2.6	9.5	12
2.7	9	11.5
2.8	8.5	11
2.9	8	10.5
3	7.4	10
3.1	7	9.5
3.2	6.5	9
3.3	6.1	8.5
3.4	5.6	8.1
3.5	5.2	7.7
3.6	4.8	7.3
3.7	4.4	6.8
3.8	4	6.4
3.9	3.5	6
4	3.2	5.6
4.1	2.8	5.2
4.2	2.4	4.9
4.3	2.1	4.5
4.4	1.7	4.1
4.5	1.4	3.8
4.6	1	3.4
4.7	0.7	3.1
4.8	0.3	2.7
4.9	0	2.4
5	0	2
5.1	0	1.7
5.2	0	1.3
5.3	0	1
5.4	0	0.7
5.5	0	0.4
5.6	0	0.1
5.7	0	0

I'll let you make any inferences from this.

Using this information

Source: Dividend Freedom Tribe (click image to zoom)

The way we use this information can be best understood by looking at the layout we have opted for in MAD Plus (the companion app members get when they join the DFT).For each stock, you get a view which gives you the MAD Chart, the yield, the historical range of yields, the required growth rate, as well as historical growth rates, payout ratios, and valuation metrics.

The view is optimized for dividend investors, as it gives you all the numbers required to kickstart an analysis of a stock.

Basically we would:

• Compare the required growth rate to the historical growth rates and put them in perspective with the payout ratios: is there room to grow more?
• Compare the yield to the historical range of yields: Does the stock seem undervalued to it's dividend? What about relative to other valuation metrics/
• Have extra metrics to provide information: We also have our dividend strength and stock strength scores give us a feel for the overall profile of a stock.

Conclusion

As you can see, having the required growth rate for all your investments helps you make better decisions when comparing investment opportunities.

If you want to get access to all of these, you get the MAD Plus companion web application for free when you join the Dividend Freedom Tribe.

Otherwise you can come back to this page every time you look at a stock, and check the table we posted above.

If you do decide you want to join the Tribe, you can test run it for free for 2 weeks. Plus we're running special discounts for the End of the Year.

Click here to find out more.