I previously posted about one of my purchases in AT&T and compared their dividend growth to a fast-growing company but with a lower dividend, Visa. This sparked some interest and I’d like to go into a little more detail on this topic.
What is better?
Well in short, I believe it depends on your time frame. A dividend growth investor that is just starting out might prefer higher growth with lower to medium yield stocks versus someone much closer to retirement that needs to live off of this income much sooner. The longer you have for compounding to work its magic, the more you should look to add some growth to your portfolio.
The Rule of 72
Everyone should know this simple rule for figuring out the time it takes your investments to double. It’s a very close approximation for normal interest rates (2%-12%). If you get outside that range, then the formula loses its precision. The way it works is that you divide your interest rate into the number 72. A 6% yield would take 12 years to double your investments because 72/6=12. An 8% yield would take 9 years to double and so on.
Drawbacks
It’s extremely difficult if not impossible to predict future dividend growth rates far into the future. The higher the growth rate and longer the time frame leaves the most room for error. The comparison I make will assume the companies continue at their same pace. There is no guarantee that this will happen. This will be more of an exercise to see what could happen based on past growth.
Example
I’ve created a spreadsheet that shows you the income thrown off from a $10,000 investment in 7 different companies with very different starting yields and dividend growth rates. These are real companies and I used the 5-year CAGR for most of the dividend growth rates. If you download the spreadsheet you can make changes anywhere there are yellow highlights.
Let’s look at one of the higher yielders, AT&T (Income B and Value B columns). A $10,000 investment in AT&T will earn you $500 over 12 months since they are yielding 5.0%. Each year the dividend increases by 5%. For someone retiring in 10 years, it might be important to see the income thrown off after the 10 years. If you move down to the 10th row denoted by the number 10 and over to Income B, you will see that AT&T would produce over $775 in dividends. You will also notice that the value of your shares would be over 15k assuming the share price keeps up with current yield.
Notice that I put Visa’s current yield and extremely high 5-year CAGR of 45%. VISA’s dividend income at that growth rates will catch and surpass any of these other companies in just 8 years! Even with a starting yield of 0.75%. I highly doubt VISA can sustain this type of growth. It might be more suitable to replace the value with 20% instead. I will let you play with it if you’d like.
These calculations assume no dividend reinvestment. However, If you actually add values to the yearly contribution and contribution increase that’s highlighted above, you could simulate the collecting of dividends until the end of the year and then reinvesting. Since AT&T pays a dividend of $500 the first year, you can just add $500 to the yearly contribution and 5% to the contribution increase since that’s the dividend growth rate. You’d have to do this again for each specific stock. The main purpose of the contributions were to put in my yearly contribution amount since I’m in my accumulation phase.
You can also think of columns A, B, C, D, E, F, and G as different portfolios with different starting yields and growth rates. You can also set the last contribution year. For instance ,if you wanted to retire in 15 years, you might want to set the Last Contribution Year to 15.
Here’s a link to the spreadsheet and it can also be found on my resources page.
Thanks for the comparison!
Regards,
Dear Dividend
Dear Dividend,
I’m glad you liked it.
Cheers!
A good discussion Dan. I’ve always been more of a dividend growth guy. The growth shows me that 1)managers are confident in their company and 2) the business continues to throw off solid cash flow to cover the rising dividend. Plus, being in my 30s…..i figure you and I have time. Have a great weekend
-Bryan
Income Surfer recently posted…Purchased This Week
Haha, sorry AA…..I changed tabs without realizing it. Oops
Income Surfer recently posted…Purchased This Week
No worries, I hope you had a great weekend!
Brent,
Way cool spreadsheet!
I also agree it depends on your time frame. Ultimately, I prefer to have investments in all three stages, or categories of dividend growth stocks, all of which have varying degrees of current yield and growth. The stocks with lower yields and higher growth rates have actually been my strongest performers in aggregate, all considered. But the big question is whether or not that growth can continue. And because I don’t know, I also choose to invest in companies that give me a good helping of that cash flow now. I get a good portion of my capital basically returned to me, which really reduces my risk. And that’s basically the crux of it. The stocks with really low yields and bigger growth rates (like V) simply have a riskier investment profile, because of the unknowns involving time and growth. Stocks like AT&T offer much less risk because you’re getting so much capital returned to you on a regular basis. But, typically speaking, risk and reward are related. Higher risk = higher reward, for the most part.
Best wishes!
Dividend Mantra recently posted…Recent Buy
Jason,
Thanks, I’m glad you liked it. I remember reading your article you wrote and totally agree about the different stages of growth. I’m with you on picking up a lot of companies that are delivering dividends now because who knows what will happen in the future. It’s so difficult to predict very far with much accuracy. You’re right about risk and reward. I’ll take a little of each to protect my portfolio and hopefully give it the needed growth it needs.
Thanks for stopping by!
I really like this post and I am considering a growth stock with no dividend yield in my portfolio. BRK.B is the only growth stock without a yield that I would consider, however I have to do a little more research here because I really hate not receiving any quarterly dividends. I do like the fact that BRK.B is more like an index fund because it involves numerous investments that often beat the S&P. The only con to investing in BRK.B besides the fact that there is no dividend yield is that if Warren passes away this stock could lose some value. So I would consider this a 5-7 year investment. Any thoughts?
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Hi Dividend Mongrel,
I think it’s ok to have some stocks like that. A lot of people go for all growth. However, I’m investing for income growth and have a little different strategy. I think you could keep a mixed strategy and still do well. For me personally, I’d rather own the individual companies that Buffett buys instead of his company. However, he does get better deals and pricing than any investor gets so you could do well there. BRK.B might take a little hit but a lot of the decisions are being made by other people already. I think you’d be ok. That’s why it’s important to monitor each company you own. I say if you are comfortable with the company then go for it. There’s no reason to think that BRK.B won’t continue producing great returns.
Take care!
Dividend growth and dividend yield – that is a big problem for me.
I like the big dividend yield from AT&T – but they have only a very small dividend growth!
With your great Excel-Sheet I can work very good!
Thank you so much!
Best whishes!
Michael
Hi Michael,
You’re welcome. It depends a lot on what you are trying to accomplish and your time-frame. I’m glad this sheet is helpful.
Cheers!
As a dividend growth investor this has been a common thought. Yield now or yield later. So I just said crew it and buy both type of stocks lol. Usually my minimum dividend threshold is about 2% but I made an exception for Visa as their upside potential in dividend and share price growth is huge.
Asset-Grinder recently posted…$2,111,481 My Net Worth Update July 2014
Hi A-G,
I’m with you, I own both stocks as well. I also made an exception for Visa, I figured I need to boost the growth of my portfolio a little. I like a combination of high growth and high dividends for balance.
Take care!
I really like your spreadsheet, I will try to see if I can utilize it next time I am looking at getting stocks.
I agree with others that your time frame matters, for someone like myself in my later 20’s growth is very important.
Kipp recently posted…Life Insurance – A Penalty of Debt
Hi Kipp,
I’m glad you liked it and hope you can find it useful. It’s really pretty simple to use.
Wow, congrats on getting started early. I wish I would have started investing in dividend stocks in my 20’s.
Thanks for stopping by!
Thanks for sharing Brent…I’m slowly favoring dividend growth over dividend yield within our family’s portfolio.
Great spreadsheet. The comparison only helps me justify the transition. 🙂
Best wishes for continued growth! AFFJ
A Frugal Family’s Journey recently posted…Stocks Added to Blog Collection (Update) – Mid-Month (July 2014)
FFJ,
No problem, and I think dividend growth is important. It’s even more important with more time on your hands.
I’m glad you found the spreadsheet useful.
Thanks for stopping by!
Great post! I myself struggle with balancing yield and growth and throw in total returns over a 5 year period just to keep myself from twisting too much with the quarterly cycle. Interesting that you cited AT&T; I opted for HCP given the choice. Lower dividend growth, but – fingers crossed -better price appreciation.
Hi bericm,
Why did you compare HCP to AT&T. I’m assuming you meant OHI. I included OHI because it’s the only REIT I actually own. I think HCP could be good as well.
Thanks for stopping by!
Also agreed that it’s an excellent spreadsheet. Just a bit counterintuitive to me why income is not to the right of value column for each respective group.
The examples for each group is a very nice addition.
Thanks for the math. I love math.
Wallet Engineer #1 recently posted…Intrafamily Mortgages Are Pretty Damn Sweet
Hi Wallet,
That was just personal preference. Feel free to shift the columns around to your liking. The formulas should stay updated.
I’m pretty decent with spreadsheet formulas so if you have any recommendations to add to this I’d love to hear it. I’ll keep the latest version in my resources section.
Thanks for stopping by!
Great comparisons and chart. Very useful to visualize what dividend growth vs. yield can do to a stock over the long run. This is a classic argument every dividend investor faces. Of course, the solution is simply to have a balance of several types of dividend stocks. High yield/low growth, med yield/med growth and low yield/ high growth. Thanks for sharing.
DivHut recently posted…Dividend Stocks That Won’t Give You The Jitters
DivHut,
Thanks, I’m glad you found it useful. I agree and think it’s important to have both fast growers with a low yield mixed in with slow growers with high yields.
Thanks for stopping by!