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Income Growth Rate and Chowder Rule Comparison.


Let's look at the Chowder Rule and see how it relates to long term income growth for retirees in the distribution phase, after all we are Divided and Growth Investors. So how important is the growth aspect of DGI. Paul Wagner calls himself a Growth and Income Investor so I asked myself why did he put Growth in front of Income. What does he know that we should know?

As a retiree I am in the distribution phase and taking my dividend income for monthly expenses and as such I do not reinvest the dividends back into the portfolio.

One of the stalwarts from Seeking Alpha Dividend and Income section is a man named Chowder. He insists on buying quality first and foremost and he has some rules of thumb for total return or the Chowder rule, when selecting stocks.

Total return (Chowder Number) = the Dividend Yield added to the 5 yr Dividend Growth Rate (DGR).

Here is a more complete understanding of the Chowder rule from Chowder himself. David Fish publishes the US Dividend Champions spread sheet every month on stocks that have increased their dividend over 5yrs, 10yrs and 25yrs and includes the information found below. The CCC list can be found here.

For utilities and telcom stocks, Chowder rule = 8
For core CCC stocks the Chowder rule number should be 12
For speculative stocks with low yields the number should be 15.

From my understanding the "Chowder" number is really meant to be applied when you purchase a stock and may vary after the stock is purchased. As the valuation affects the dividend Yield. I believe he is stressing that stocks should be purchased with valuation in mind. If possible don't overpay for a stock.

If you are a Dividend and Growth Investor, both of these metrics are important to you as a long term investor. Let look at three stocks with nearly equal Chowder numbers and see how the dividend payment could grow over time.

For this exercise I have only looked at the growth rate of the dividend and not the value of the stock over time. It is assumed that you as an investor have done your due diligence and your selected stock earnings will continue to grow over time to support the current 5yr DGR.

I selected three stocks Hersey (NYSE:HSY), Owens & Minor (NYSE:OMI) and Chevron (NYSE:CVX) all from David Fishes CCC list dated 29April 2015.

I picked these three as they all have similar Chowder numbers but the current Yield varies from 2.34% for HSY, 3.01% for OMI and 3.85 for CVX.

HSY has a dividend yield of 2.34% and a DGR of 11.4% for a Chowder number of 13.73.

OMI has a dividend yield of 3.01% and a DGR of 10.3% for a Chowder number of 13.3.

CVX has a dividend yield of 3.85% and a DGR of 9.6% for a chowder number of 13.45

I also put ATT (NYSE:T) into the mix as many DG investors have T in their portfolio because of the high Yield. However the growth rate is around 2.3% so the income it gives will not be growing at the same rate as HSY, OMI and CVX.

For T, the recent yield is 5.43% and the 5yr DGR is 2.3% so the Chowder number is 7.73. Close enough to 8 for me for this exercise.

In the graph below you can see T's income starts out higher but is quickly over taken by CVX within 6 years, OMI within 9 years and HSY within 13 years.

Different combinations of Chowder numbers have different long term growth rates so it worth looking at these growth rates so you as an investor can make intelligent decisions about how to achieve you long term income growth rates.

While it is important to have some companies with higher yield to boost the income during the early retirement years it is equally important to have some higher growth companies in the mix to help with income later in retirement.

This growth perspective also applies to a young investor with 20-30 years until retirement, so they can maximize their income as they approach retirement. What is not discussed here is the compound effect of reinvesting the dividends which would add to the growth of the income and the number of shares owned.

It makes sense, that for a given category of Chowder number (total return), that over the long term the stock with a higher growth rate will give more income than the stock with a lower growth rate. Seeing this effect graphically helps me visualize how important growth rate is and what a big difference it can make in the long term.

You can have both stocks with Chowder numbers of 8 and 12 in a portfolio, but overall IMHO you may want to strive for a portfolio income growth rate that is higher than inflation in the 4-6% range. What you don't want is a low yield dividend stock that has a low growth rate.

Now I realize that the growth rate may vary over time but without that Crystal Ball, the best we can do is select solid quality companies and use the past DGR as a guide.

Disclosure: The author is long CVX, T.