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I have been getting a whole bunch of emails recently asking me for my picks of the highest dividend yielding stocks that I would recommend buying. I think this really speaks to two factors at play here. First, I do not make recommendations on what stocks to buy. I am not a financial advisor nor am I licensed to offer investment advice. Second, when trying to build a dividend portfolio it is not the dividend yield that is important – it is the dividend growth!
Dividend yield is simply the dividends per share divided by the share price of the company. Basically, what it tells an investor is at that point in time, your stock will yield dividend payments of X%. If the dividend per share of a company is $1.25 per year and the stock trades at $50 per share, then that stock is currently yielding 2.5%. If you bought that stock at $50 your yield would therefor be 2.5%. Sure it is great that you are receiving this income from the company, however there is something even more powerful that will impact your dividend income and ultimately your portfolio returns over a longer period of time. That force is called dividend growth.
Dividend growth occurs when a company consistently raises the dividend it pays to shareholders. Many companies do this on a yearly basis, and those are the stocks that I try to focus on in the individual stock component of my portfolio. The reason comes to down to one of the most basic of investment principles, yet one of the most important. Compounding Returns. As a company increases their dividends, that means investors receive more and more income. Over time these returns compound into more and more income. The image below really sums this up:
Click to EnlargeTherefore, if you are trying to add individual securities to your own portfolio, do not focus on the dividend yield as the be all and end all. Rather, focus on the dividend growth that company has experienced and before long your yield on investment will go through the roof.
Hi,
I think that far too many investors focus on current yield. While current yield is great for those entering their retirement years (as long as it is sustainable) for those of us accumulating wealth we need dividend growth to beat inflation.
I wrote a little scenario about the need for dividend growth to beat inflation a few days ago on my blog if you are interested.
Great post – young dividend investors really do need to focus on dividend growth versus dividend yield.
I definitely know what you mean. Young investors like myself tend to focus on yields rather than dividend growth, and I agree with you that’s a mistake!
I’m in the middle of setting up a conservative DIY dividend “fund”, so this is all quite timely. I certainly see the point, but I’ve been wondering about opportunity cost. It’s great that one’s initial $100 investment had a dividend that went from $2.50 to $5.00 per year and effective yield has doubled from 2.5% to 5%. But imagine the price of the stock went from $100 to $200 at the same time (i.e. same P/E ratio and payout ratio). One could then sell, take that $200 and invest in some other company paying 2.5% yield and get the same $5 per year. Which is better would depend on which company is better I suppose. Maybe the point is a reliable grower is less likely to cut dividends than a freshstart. Or is it that a reliable grower yields reliable value increases of the stock? I am thinking it is important to keep tabs on both dividend growth and on current yields of other competing opportunities.
Which would you rather have:
A stock yielding 2 percent and the dividend growing at 10 percent per year OR a stock yielding 10 percent and the dividend growing at 2 percent per year.
Before you answer, work out the math!
Along with yield and growth look at the amount of time the company has been paying dividends. Some really high yield companies have reduced or stopped dividends all together in the last 9 months with the sub-prime mess.
For all of the young investors out there they might want to look into direct purchase plans, and eliminate broker fees. Some companies with direct plans even pay the fees for you. I have put together a web site with over 150 companies that offer direct purchase plans. It’s FREE for anyone that wants to look at it just go to http://www.aplussrc.com
My per share cost at this time os only .34 and the great thing is you can buy stock in companies for as little as $25 to $50 a month. A great way to build a position over the long term.
Bob, – I love your restaurant!
Well, a truly diversified dividend portfolio should contain both high-yielding, slow growing dividend payers as well as lower yielding faster dividend growers.
The perfect dividend stock is one the increases its dividends above the rate of inflation, while maintaing an above average dividend yield as well as performing above the market over a period of 5-10 years.
“Which would you rather have:
A stock yielding 2 percent and the dividend growing at 10 percent per year OR a stock yielding 10 percent and the dividend growing at 2 percent per year.”
That’s a good question. On a dividend received basis the faster growth looks to take about 30 years to break even – those early high dividends really pay off, and within ten years you’ve recouped your initial investment, which is a happy little safety net if you don’t reinvest in the same stock. On the other hand, if (?) the price/dividend ratio is constant then the fast growing dividend would have yielded an enormous increase in stock price, whereas the high yielder would have changed only a little – with just a 6 year total return breakeven point. The trick I suppose is to find a company that can raise profits 10% per year in an economy growing at 3% a year, and do that for 30 years without getting stuck. So my answer is probably to have a little of both and hedge my bets, since the real enemy is the fickle winds of business, I reckon.
The question that Michael Barany asked could be solved using a perfect world scenario and the answer would be – it doesn’t matter.
Fascinating..
Yield and growth are equally important. Gordon Equation states that:
Dividend TOTAL return = Dividend Yield + Dividend Growth
A 2% yielding, 10% growing stock generates an identical return as a 10% yielding, 2% growing stock no matter what time frame you are looking at.
How does a retail invstor compile a list of those companies with the best records for raising dividends for long periods. I have access to Globe and mail gold if there is anything on that site which would help. thanks, Carl
..[The Dividend Guy asks his readers which one is more important, Dividend Yield or Dividend Growth?]..
Thank you Dividend Guy for this symposium.
“The math”, has had me trying to find both high yield, and high dividend-growth, stocks. Because it’s hard to find companies which grow their dividends at consistently high rates over long periods, a high d-g stock may never catch up to a high yielder.
However, Danger Dan, and Financial Jungle, broadened the context for me and made me consider an additional feature of high d-g stocks; that of a corresponding growth in price.
Thanks to this, I am now a little wiser.
Do you have anything that would make me a little smarter?
Carl:
Try Mergent’s Dividend Achievers website
The only rational way to understand whether or not a company will maintain healthy market returns for the Long Term is to use the Gordon equation DR (market returns)= Dividend Yield + Dividend Growth.
The market is too unpredictable and the vast majority of financial planners don’t understand the basics of finance. The US and the World is in the beginning of a major recession which I believe will last many years since we have had such a long run of stock market price appreciation and a capital bubble created by easy credit and the stupidity of Banks and Investment firms along with the stupidity of the vast majority of people who got sucked into buying beyond their financial means.
If you are young and have lots of cash this is the best moment in history or probably in your lifetime to get rich. All you have to do is have patience and watch the market decline in the next year or so. You will have fantastic opportunities to buy great companies at bargain prices.
One of the best books written on investing is “The Four Pillars of Investing” buy William Bernstein. A must read for all intelligent investors.
Hi Dividend Guy:
I just read your “about me” and would like to say your investment philosophy is very similar to mine. I agree with everything you have posted. You are far better off to manage your own portfolio, alhough, it means a lot of work ie studying finance and investing and keeping on top of your investments and investment strategy. I think for most investors who don’t have the time and energy “indexing” is far better than mutual funds. Although in today’s climate I wouldn’t invest at all in the stock market. I have sold all my holdings and everything is in cash ie a short term money market fund. Although, I am hardlly making any money at least I am not losing money and can wait until real bargains start to appear in the marketplace. I am close to retirement but retiring in a Bear market would be a stupid thing to do so I am waiting a couple of years until the next Bull to retire.
All the Best
Mark
Where can I find a good financial advisor/money manager that specializes in investing for retirement accounts in a decent portfolio of dividend paying stocks that will yield an average of 7% or better to allow monthly income for the investor/retiree in his IRA account? It seems really difficult to find such a money manager.
Sincerely,
Sid