Yesterday I kicked off a series of threads discussing my entry criteria for a dividend growth stock by discussing the number of years a company has been raising its dividend. The next thing that I look at, the topic of today’s post, is the stock’s dividend growth, as measured by its current dividend yield and the dividend growth rate.
Just in case this is a new concept to you, the current dividend yield of a stock is simply the current amount of dividends (annualized) that the stock currently pays divided by the current price of the stock. For example, Aflac (AFL) currently pays $0.35 per share each quarter. That’s $1.40 annually for each share. The price is $51.64 as of Friday’s close. $1.40 divided by $51.64 is just about 2.7 percent. If a stock’s price does not move much, then the dividend yield increases when the dividend payout increases. Similarly, a rise in the stock price lowers the dividend yield, and a drop in the share price increases the yield. The dividend growth rate is just that: the rate at which the dividend grows year over year.
Many dividend growth investors have a minimum current dividend yield that they will accept when weighing DG stocks, often in the 2.5 to 3.5 percent range, with 3 percent being pretty common. Personally, I do not have a fixed minimum. As always, I think that each stock has to be evaluated on its own merits in light of all of the relevant factors. So I do have a few low-yielders in my portfolio. That said, I must admit to a pretty heavy bias toward stocks with a higher current dividend yield.
The current dividend yield of the stock and the rate at which the dividend grows year over year are the two main components of dividend growth. It is a rare stock indeed that has a high current yield and that is also growing the dividend at a fast pace year over year. One example of this is Lockheed Martin (LMT). Currently yielding a generous 5 percent (approximately), LMT has also been growing the dividend at an average rate of over 20 percent each year for the last five years. There are other reasons to think twice about LMT (sequester, earnings trajectory), but it is hard to argue with LMT’s winning combination of dividend growth factors. More commonly, you’ll see a stock with a high current yield will be growing its dividend more slowly (think AT&T, for example), or a stock with a lower current yield but that is growing more quickly (can’t think of an example off the top of my head).
Many of the most popular DG stocks, however, live somewhere in the middle, sporting current dividend yields in the 2 to 4 percent range and average annual dividend growth rates in the 5 to 15 percent range. These are your JNJs, MCDs, and PGs. These are often thought of as core DG holdings because of the great combination of good current yield plus (relatively) steady and predictable dividend growth.
I love these types of stocks, and they make up a large portion of my DG portfolio. But in weighing current dividend yield against the rate of dividend growth, I give a little extra weight to current yield. Over a long period of time, a low current yield that grows more quickly may provide much higher returns than a higher current yield that is growing more slowly. The difference to me (and reasonable minds may certainly differ about this) is that the higher current yield is a bird in the hand, while the faster dividend growth rate is two in the bush. You cannot predict so well how long a higher dividend growth rate will be sustainable. In the LMT example, if they do not get their earnings moving in the right direction again, there is little reason to hope that they will be able to continue to grow the dividend at such a fast rate for much longer.
Of course, both of these factors are important to consider, as together they make up the “dividend growth” part of “dividend growth investing.”
In the next few days, I’ll add another post in this series about the next entry criteria I consider: the payout ratio.
Just in case this is a new concept to you, the current dividend yield of a stock is simply the current amount of dividends (annualized) that the stock currently pays divided by the current price of the stock. For example, Aflac (AFL) currently pays $0.35 per share each quarter. That’s $1.40 annually for each share. The price is $51.64 as of Friday’s close. $1.40 divided by $51.64 is just about 2.7 percent. If a stock’s price does not move much, then the dividend yield increases when the dividend payout increases. Similarly, a rise in the stock price lowers the dividend yield, and a drop in the share price increases the yield. The dividend growth rate is just that: the rate at which the dividend grows year over year.
Many dividend growth investors have a minimum current dividend yield that they will accept when weighing DG stocks, often in the 2.5 to 3.5 percent range, with 3 percent being pretty common. Personally, I do not have a fixed minimum. As always, I think that each stock has to be evaluated on its own merits in light of all of the relevant factors. So I do have a few low-yielders in my portfolio. That said, I must admit to a pretty heavy bias toward stocks with a higher current dividend yield.
The current dividend yield of the stock and the rate at which the dividend grows year over year are the two main components of dividend growth. It is a rare stock indeed that has a high current yield and that is also growing the dividend at a fast pace year over year. One example of this is Lockheed Martin (LMT). Currently yielding a generous 5 percent (approximately), LMT has also been growing the dividend at an average rate of over 20 percent each year for the last five years. There are other reasons to think twice about LMT (sequester, earnings trajectory), but it is hard to argue with LMT’s winning combination of dividend growth factors. More commonly, you’ll see a stock with a high current yield will be growing its dividend more slowly (think AT&T, for example), or a stock with a lower current yield but that is growing more quickly (can’t think of an example off the top of my head).
Many of the most popular DG stocks, however, live somewhere in the middle, sporting current dividend yields in the 2 to 4 percent range and average annual dividend growth rates in the 5 to 15 percent range. These are your JNJs, MCDs, and PGs. These are often thought of as core DG holdings because of the great combination of good current yield plus (relatively) steady and predictable dividend growth.
I love these types of stocks, and they make up a large portion of my DG portfolio. But in weighing current dividend yield against the rate of dividend growth, I give a little extra weight to current yield. Over a long period of time, a low current yield that grows more quickly may provide much higher returns than a higher current yield that is growing more slowly. The difference to me (and reasonable minds may certainly differ about this) is that the higher current yield is a bird in the hand, while the faster dividend growth rate is two in the bush. You cannot predict so well how long a higher dividend growth rate will be sustainable. In the LMT example, if they do not get their earnings moving in the right direction again, there is little reason to hope that they will be able to continue to grow the dividend at such a fast rate for much longer.
Of course, both of these factors are important to consider, as together they make up the “dividend growth” part of “dividend growth investing.”
In the next few days, I’ll add another post in this series about the next entry criteria I consider: the payout ratio.
