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.
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.
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.