Monday, July 28, 2014

Dividend Yield or Dividend Growth:My Experience With Both

There is a ranging debate of whether someone should go with high yielding companies today, or they should go with lower yielding investments, which however offer the promise of increasing payouts at a faster clip. As I have discussed earlier, there is a tradeoff between dividend yield and dividend growth, with the decision of which path to take ultimately being dependent on the underlying unique characteristics that an investor has in his or her own opportunity set.

Nevertheless, I still get asked the following question. The question goes something like this: Why go for an investment that yields 3%, with the potential for a 7% in annual dividend growth, when someone can get an investment yielding 6% today? Even if all the expectations turn out to be correct, an investor would have to wait for a long ten years, before they collect a 6% yield on their cost. With the other investment, they would have been collecting that 6% yield for 10 years already.

I usually answer those questions with examples, which discuss the probabilities of different events happening. However, the reason why I usually go with the lower yielding stock is due to my experiences. Actually, one of my investing mistakes pretty much sums up why I do what I do.

I will tell you what the risks behind the thinking in the question asked above are, by discussing my experience with ONEOK Inc (OKE).

I bought shares of ONEOK Inc (OKE) in three separate transactions in 2010 – 2011 at the following price points - $25.31, $25.71 and $30.20. I liked the fact that shares were offered at a low P/E ratio, had adequate current yield, and offered the opportunity for growth. As a general partner in ONEOK Partners (OKS), there was plenty of opportunity for growth. And I think there still is. ONEOK Inc paid a quarterly dividend of approximately 21/cents per share.

In 2011, I decided that I wanted to earn more in distribution income right away, rather than wait for a few years. I also believed that the shares were too high. So I ended up selling all my shares at $36.18/share and purchasing shares of ONEOK Partners at $41.71/unit.

Since then, ONEOK Inc spun-off One Gas (OGS). Investors received one share of One Gas (OGS) stock for every four shares of ONEOK Inc (OKE). If I had stayed with ONEOK Inc, I would be earning a quarterly dividend of 56 cents/share from ONEOK shares as well as dividends from One Gas shares, where rate is 28 cents/quarter. This comes out to a total of 63 cents/quarter for shares that were bought at an average price of $27.07/share, or an yield on cost of 9.30%. Instead, I am earning an yield on cost of 7.10% by sticking to ONEOK Partners (OKS). If growth continues further, as it should, investors in ONEOK Inc will be generating even higher yields on cost, due to high distribution growth.

I violated two of my rules. One is never to sell, even if I had a 1000% gain on the investment.  The other rule is that activity is bad for your performance. According to research, 80% of the time the investor is better off staying with their original investment and not doing anything else. I also chased yield by replacing ONEOK Inc (OKE) with ONEOK Partners (OKS).

I also ended up paying taxes on a portion of the gains. The opportunity cost of the taxes I paid could be very high, because this is money that could have quietly compounded for decades for me and made me even wealthier in the future. It could have meant more money for the causes and people I care about when I die. Instead, I threw the money away and gave it to the government.

Overall, the investment in ONEOK Partners has been satisfactory. However, I made a few mistakes, and probably should not have sold the original shares purchased in ONEOK Inc. Once again, as Warren Buffett says, some of the largest mistakes he has made were mistakes of omission, not mistakes of commission. Other mistakes of omission I have made include watching Williams Companies (WMB) go from $32 to $36 in 2013, and not purchasing because I wanted to buy it cheaper. The company might still be a good investment, given the high forecasted growth in dividends. As a matter of fact I recently initiated a position in it, and I am hoping it drops from here.

I believe that smart people, learn from the mistakes of others. Hence, I hope that my smart readers will learn from those mistakes I made. The goal of every investor is to always be learning, and always be improving. If one stops learning and improving, they have a high chance of failing to reach their goals and objectives. The goal is to get a little smarter every single day, and removing ignorance one item at a time.

Relevant Articles:

The Tradeoff between Dividend Yield and Dividend Growth
Why I am replacing ConEdison (ED) with ONEOK Partners
ONEOK Partners (OKS) Dividend Stock Analysis
Seven Dividend Stocks I purchased for the long-term
Types of dividend growth stocks

11 comments:

  1. "Nevertheless, I still get asked the following question. The question goes something like this: Why go for an investment that yields 3%, with the potential for a 7% in annual dividend growth, when someone can get an investment yielding 6% today? Even if all the expectations turn out to be correct, an investor would have to wait for a long seven years, before they collect a 6% yield on their cost. With the other investment, they would have been collecting that 6% yield for 7 years already."

    I think you mean 4 % not 3 %. To turn in a YOC of 6 % after 7 years.

    Regards,
    ZaVodou

    ReplyDelete
    Replies
    1. Hi ZaVodou,

      Thanks for reading the site and catching the error. I kept the 3% yield, but changed the text to 10 years from 7 years.

      Best Regards,

      DGI

      Delete
    2. i have susbscribed to almost every dividend letter any one writes.....but you really have an edge on quality......keep ie up ...jay

      Delete
  2. DGI,
    I agree with Jay, your site is the first one I read every day. Thanks!
    KeithX

    ReplyDelete
  3. First site I turn to every morning. Thank you DGI

    ReplyDelete
  4. Good advice DGI....chased yield on WIN and holding on for now.

    ReplyDelete
  5. Just found this site, and really enjoy it, excellent writing. Where did you find that stat about 80% of the time it pays to sit tight. I happen to agree but have never heard the stat. Thanks!

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  6. I agree. I hold 80% of my assets in a dividend growth account and I have 20% in a high yield account filled with REIT and telco stocks. Let the blue chips do their thing but very actively manage the riskier high yield portfolio. Best of both worlds

    ReplyDelete
    Replies
    1. I agree with you I do the same and am enjoying watching my dividends come in.

      Delete
  7. What I want to know is why did you not keep your original stock and also buy the other stock? Would that have been breaking any rules? I plan on adding kmi and I already own kmr. I like both for different reasons. I have 2 high yielders, 2 moderate yielders, and my blue chips, aristocrats, champions, and challangers. Oh and Altria which I was blessed to have purchased at $14.

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  8. DGI and Seeking Alpha are my first reads of the day. DGI is first rate and tells it exactly as he sees it. Very good advice for both the seasoned and new investor of Dividend Stocks.

    Grant

    ReplyDelete

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