Why you need to account for dividend growth
By: IS
Just a small clarification to start off. This post was first published in our IntelligentSpeculator free newsletter. We do not usually republish that material on here but received a lot of requests to add it on here. You might want to subscribe to our mailing list to get such information in the future, it is free:)
Name:
Email:
*******************************************************************************
As you can imagine, there is a major difference between a stock that yields a steady 3% dividend yield and one that pays 3% but is increasing the dividend every year. Over time, the gap between the two can become huge. The challenge however is how to value that difference. There is no right or wrong way to do it but here are some ideas.
Current Yield?
Investors often make the mistake of only looking at the current yield. That can be grossly misleading. Let’s take our YYY stock. When it was traded at 10$ and had a $0.50 dividend the stock was trading at a 5% dividend yield right?
Take that stock a few years later and it might be paying 1$ annually but the stock price might very well be 20$. That comes out to the exact same yield of course but in reality you prefer this stock over another one that would have stayed with a $0.50 dividend. Obviously! No we’re not even considering the gain on the stock here (which would make things even easier to analyze) but simply the dividend.
How to account for the growth?
When you look at the dividend yield, you could take other factors into consideration when filtering. For example, you could get the Dividend Yield but also the 2 year and 5 year expected yields. How?
Many companies are very predictable when it comes to dividend hikes. If you know that company YYY should hike its dividend to $0.60 in 2 years, the expected 2y yield would be 6%. What does that mean? It means that compared with your purchase price, the dividend will be paying 6% 2 years from now. These are projections of course but isn’t that what finance is anyway?
If stock YYY will be paying 1$ 5 years from now the “Expected 5Y. Yield would be 10%. At that point you will be happy to not have picked the steady dividend.
Again, in this post, the 5 year expected yield is NOT the yield you will make in the first 5 years but rather the yield you will be earning compared with your purchase price 5 years ago.
Of course, all of this assumes the stock price remains steady. In reality it could increase or decrease!
Here is a good example: Proctor & Gamble (PG)
What to avoid?
If there is one thing you want to avoid when building such a portfolio, it is investing in a company that either cannot maintain its current dividend growth or even worse, one that cannot even pay for its current dividend. Just look at GE’s dividend progression. No need to tell you that those who had expected a steady increase in dividends lost big time.
Here is a good example: General Electric (GE)
http://www.intelligentspeculator.net/investment-talking/why-you-need-to-account-for-dividend-growth/
Accueil 
