Most dividend investors are influenced by the current yield when they enter a particular stock investment. Dividend growth investors are no different either. It is hard to blame either of these groups, as there is no point in a company that strongly raises its dividend payments, yet it might take up to two decades for the yield on cost to reach any meaningful level. Add in to that the fact that a double digit dividend growth could only be supported by a double digit earnings growth only for so long. If the dividend payout ratio was low at the beginning this could extend the strong dividend growth by a few years after earnings growth slows down to a more reasonable level.
Some of the best dividend growth stocks however would always spot a low current yield, coupled with strong dividend growth for many years to come. As some might typically yield 1% or 2 %, they would be completely ignored by most investors. The trick here is that a company that yields 2% today and raises its dividend by 12% every year would double your yield on cost in just 6 years. In most cases such companies stock prices also tend to follow the changes in the dividend payment, which could lead to strong capital gains over time. Thus, if the stock increased distributions by 12%, it is very likely that the stock price might increase by about 12% as well. This leaves the dividend yield unchanged at 2%, which doesn’t matter much for original investors, who purchased the stock 6 years earlier.
In my experience as a dividend investor I have always implemented a minimum yield criterion of between 2% to 3% when screening for dividend growth stocks. I implemented this control in order to protect myself in the event that the company I am heavily invested in stops raising distributions. That way I could at least receive some return on my investment until I try to unload my position above my breakeven price.
Looking back at the best dividend growth stories of Wal-Mart (WMT) and McDonald’s (MCD) however, my minimum criteria would have prevented me from getting aboard on these success stories. Other investors who are currently seeking high current income might also have missed out on these plays, which are delivering double-digit yields on cost for anyone who purchased Wal-Mart of McDonald’s in the 1980s.
I recently came out with a way to tweak my entry criteria of 3% minimum initial yield by grouping higher yielding and lower yielding investments with my purchase. At the end of the date, one could easily create a dividend portfolio which consists both of high yielders with slow to no dividend growth and low dividend yielders, which have the potential for strong dividend growth. If one manages to allocate the varying dividend components in their portfolio carefully, they would be able to achieve a target initial yield on cost for their stock holdings as a whole.
For example I recently added to my position in Wal-Mart Stores (WMT), which I consider of the best run companies in USA, with a strong position in the retail market and good opportunities for growth. The low current yield of 2.20% however was too low in comparison to the 3% entry criteria I apply for new and existing investments. I do believe however that the strong dividend growth would more than compensate for the low current yield, and I see the yield on cost on an investment in Wal-Mart today doubling to 4.5%-5% by the end of the next decade. That’s why I added the high dividend stock AT&T (T) to my portfolio. For every two shares of Wal-Mart (WMT) stock, I bought one share of AT&T (T). At the current prices this mix yields 3% right now.
I view AT&T (T) as a slow grower, which might end up cutting distributions sometime in the future due to its high payout and stagnant earnings in the highly competitive telecom market. The strong dividend growth at Wal-Mart (WMT) however should more than compensate for any potential dividend cuts at AT&T (T). If AT&T (T) cuts its dividends by 50% to 82cents/share, but Wal-Mart (WMT) managed to raise its distributions by 36%, my total dividend income would be unchanged. I believe that Wal-Mart (WMT) would be able to raise distributions by 36% over the next 3-4 years, assuming that it follows the most recent path of dividend growth.
Other stocks that I could use in dividend grouping for income could be high yielding triple net lease real estate investment trust Realty Income (O) or pipeline operator Kinder Morgan (KMP).
Full Disclosure: Long T, KMR, MCD, O and WMT
- Six Dividend Stocks for current income
- Best Dividend Picks for 2009, 3Q update
- Emotionless Dividend Investing
- Dividends Stocks versus Fixed Income
Subscribe to:
Post Comments (Atom)
Popular Posts
-
The dividend aristocrats list shows companies in the S&P 500 index that have managed to increase dividends for at least 25 consecutiv...
-
The S&P Dividend Aristocrats index tracks companies in the S&P 500 that have increased dividends every year for at least 25 years...
-
Warren Buffett’s Berkshire Hathaway just received a dividend check for $168 million dollar from Coca-Cola. Berkshire Hathaway owns 400 mill...
-
Warren Buffett and Charlie Munger need no introduction. If you do, please check the Wikipedia entries for each fellow. I am a big fan of bot...
-
A lot of times the best investment ideas are right under our noses . As individual investors and everyday consumers, we have an edge over Wa...
-
Opportunity costs represent the potential benefits an individual, investor, or business misses out on when choosing one alternative over ano...
-
As part of my review process, I monitor the list of dividend increases every week. I usually focus on the companies with at least a ten year...
-
As part of my weekly review process, I monitor the list of dividend increases and focus on the companies with at least a ten year history of...
-
The Procter & Gamble Company (PG) provides branded consumer packaged goods to consumers in North and Latin America, Europe, the Asia Pac...
-
Nestlé S.A. operates as a food and beverage company. The company operates through Zone Europe, Middle East and North Africa; Zone Americas; ...

I think a lot of what determines allocation is time frame. I'm in my 30's, meaning that I'll have 20+ years before I start drawing on the income. Thus, I'm willing to trade a bit of current yield for future dividend growth.
ReplyDeleteOf course, that doesn't stop me from drooling over the few stocks that have both, but getting diversification is tougher since so many of them are staples.
Mike
A new book on Amazon, called Dividend Growth Investing, seems to reflect exactly what you are trying to do with your service. However, it is oriented to helping us to do dividend growth investing ourselves, if we have the time and patience to do the necessary research. You may want to review this book, as I found it very helpful.
ReplyDeleteThank you for continuing to advance the thinking in dividend growth investing.
ReplyDeleteI don't have the tools to do so, but I'd love to see someone incorporate the issue of inflation at some point. A payer that only increases the dividend at the rate of inflation doesn't do investors much good, even though the yield on cost might look great on paper.
I guess what I'm wondering is whether there's a way, looking back to some starting point, to recalculate a real yield on cost, net of inflation. It's easy enough to eyeball in any given year (especially now, with no inflation!) but seems to get obfuscated over time.
Thanks again for thinking differently about dividend growth investing.
I have been reading your blog and it has been really helpful. Thanks a lot. Sorry I don't where to leave a message for this.... but I want to know your thoughts on KMB, Kimberley Clark.....
ReplyDeleteThanks for the article! Real estate finance stuff is so hard to understand, especially terms like triple net lease and 1031 exchange property. Do you know of any good resources I could look at?
ReplyDelete