Tuesday, March 11, 2014

Dividend Growth vs Dividend Yield




There are two metrics which are king and queen for dividend-seeking investors: dividend yield and dividend growth. However, often times when comparing several investment opportunities, it becomes very important to understand exactly the impact of each of these metrics in your investments. While they are obviously both important, what would prefer, modest yield & high growth or high yield & modest growth?

The right answer is: It depends. It's easy to get carried away by double digit dividend growth, but remember that the growth is applied to the current yield, which normally is a very small number thus resulting in a small increase. So, it is important to run to the the actual calculations and understand the impact of the growth on current yields. 

As an example, I am going to use two companies loved by many dividend investors - AT&T (T) and Wal-Mart (WMT). This is just for example sake, I am not advocating investing on one over the other, nor am I taking into account the companies' underlying quality into account. I am purely looking at them from the dividend metrics perspective.

Wal-Mart
Dividend Yield: 2.57%
Dividend Growth: 15%

AT&T 
Dividend Yield: 5.5%
Dividend Growth: 2%

 At first sight, this would look like a hard decision. WMT has roughly half the dividend than T but its dividend grows at a much higher rate (7 times higher). As high as T's yield is, and as high as WMT growth is, the choice here is not obvious. Let's run some numbers and see how both yields would evolve with time:

Year
01234567
WMT (yield)
2.57%2.96%3.40%3.91%4.50%5.20%5.98%6.87%
T (yield)
5.5%5.61%5.72%5.83%5.94%6.10%6.22%6.34%

The conclusion is that, even with such a high growth, WMT's yield would only reach a comparable dividend yield to T on your 6th year holding the investment. Also, remember that it  is much easier for companies to slow down the dividend growth on tough years (as WMT did this year), than it is to actually cut their dividend, so all things being equal, there is a higher probability of the big dividend grower, to grow at a slower pace at some point in the span of 7 years.

Additionally, if you are re-investing the dividends, each year you will be entitled to a larger slice of the profits pie. So, remember that during the years where you have a higher yield, you were also re-investing a larger sum.

Of course in most cases, companies with high yields and low dividend growth are probably facing tough headwinds, while companies with low dividends and high dividend growth have confident expectations on their medium-term growth.

Ultimately, it is not trivial to choose, but the point I wanted to make with this post, was highlighting that a strong dividend growth is a future promise that might be broken, even for high-quality companies (like WMT this year). So, for me, the choice between both metrics is not obvious and I always run these calculations to be able to estimate when the growing dividend will catch up with the high yield. 

What about you, how do you decide between growth and yield?

8 comments:

  1. I think ultimately as my timeline is longer than any crossover point, I am less concerned with yield today, but instead invest in companies that I feel are going to provide the consistent level of growth I'm looking for while filing a need within my portfolio. Like yourself, I am fairly early in the accumulation stage for my DG portfolio, so down the road asset allocation and other factors will play a role in my decision making as well.

    ReplyDelete
    Replies
    1. Hi writing2reality,

      I follow the same philosophy, the longer the investment time-span the more you can wait for a cross-over point. At this point asset allocation doesn't play much of a role for me either. If I am undecided between two companies, I prefer one that is a sector I don't own yet. Apart from that, I intend to load up as much as possible on each opportunity. At the moment, I'm eyeing Unilever again.

      Delete
  2. I try to get a good mix across the Growth-Yield spectrum. I own some companies that are the really fast growers 0.5-2% yield / 15%+ growth, the "sweet spot 2.5-4% yield / 5-10% growth and the high yielders 5%+ yield / 2-4% growth. Most of my portfolio lies in the "sweet spot" but there's a place for all of them in a balanced portfolio. The higher yielders give you more dividends for your invested capital to help you invest/"reinvest" into the sweet spot and high growers.

    ReplyDelete
    Replies
    1. Hey Passive IncomePursuit,

      Spot on! I have exactly the same sweet spot and high yielder range than you. Up until now I was not considering any stock below 2% no matter what growth, but I have definitely reconsidered it. If fast growers have fast growth in EPS as well, it probably means they can provide great capital appreciation as well.

      I'm still a bit skeptical tough, a company yielding 1.5% with 15% growth would take five years to reach a 3% dividend, and five years from now there is no guarantee that the company will be in a position to keep growing the dividend so fast, while in the mean time I could have invested in a company in the sweet spot.

      Delete
  3. Hey DV, some good articles on the blog, thanks for the info. Will be following. Like the focus on some of the UK stuff esp things like Unilever. I like to find undervalued, hated stocks so i can make the $ from the capital appreciation there with the backup of solid div growth and a decent yield, obviously there is risk in that strategy.
    Keep up the good work. cheers

    ReplyDelete
    Replies
    1. Hi talesfromthetape,

      Nice to have you on-board and glad that your are enjoying the articles. I definitely have a focus on UK stocks, I'm based there and so the tax-free accounts allow me to have 0% tax on uk-based stocks, so stay tuned, because every time I find a good stock in the UK, I will definitely load up on it.

      Your strategy sounds a lot like what I'm trying to accomplish so I completely feel in tune with that, Unilever seems hated at the moment and is further going down, I am looking forward to load up on more Unilever and Amec as well here in the UK.

      Cheers!

      Delete
  4. Loved the chart analysis. I think a good mix of low yield growers and high yield low growth is the way to go. both 2 good stocks to own

    ReplyDelete
    Replies
    1. Hi Asset-Grinder,

      I'm glad you liked it! I'm definitely with you on that, a good balance is the way to go. From what I have noticed it seems that the companies with the fundamentals I prefer usually yield around 3% and have a growth around 7%.

      Delete