The word Growth is the central word in the phrase Dividend Growth Investing, yet “DGI” is often looked at as a stodgy strategy focusing on low growth, “widow and orphan” type of investments. This mis-characterization is unfortunate, because it can cause younger and/or returns-focused investors to bypass the strategy in favor of more “exciting” opportunities.
Yes, there are all kinds of boring, higher yielding, low growth companies that are considered dividend growth stocks, but there are plenty of other higher growth companies that fit under the “DGI” umbrella as well.
Growth and income aren’t mutually exclusive; there are plenty of companies growing at a double-digit rate that still offer a dividend for shareholders. While it is rare to find high growth along with a high yield, even a low starting yield can grow into a significant future income stream over the years.
Compounding is a tremendous force, especially when one is talking about double-digit growth rates. For example, a stock with just a 2% initial yield , growing at 12.5% per year, will roughly double its income potential every 5 years when dividends are reinvested. A young investor with 20, 30, or 40 years until retirement can see several doublings of their dividends, turning that initial 2% yield into substantial future income.
This relationship between initial yield, growth and future income potential can be seen in this spreadsheet matrix I built:
To use the chart, simply pick out an initial yield from the top row, and then a growth rate from the left column. The cell where they come together shows the expected yield on cost “YOC” at the end of 10 years. For example, a 3% initial yield growing at 10% per annum provides an expected YOC of 10.2% after ten years. This is close to the same result of a 5.5% initial yield growing at 1% per year.
Here is a similar chart showing expected total returns with dividends reinvested:
From the prior example we know a 3% yield growing at 10% produces roughly the same income as the 5.5% yield growing at 1% after a decade. However, this chart shows that it produces significantly more total returns for an investor, turning each dollar into $3.49 while the slower grower turns into just $1.89.
In my opinion, dividend growth investors sometimes focus too much on the dividend rather than the growth component of the equation, which can cause them to miss out on capital gains down the road.
Personally, I try to find companies that operate in a stable and consistently profitable manner, and can grow at a double-digit rate over long periods of time. These are the types of companies that can produce tremendous income potential and capital appreciation if held over multiple decades, which happens to be my investment time-frame.
I’ve written several articles on Seeking Alpha over the years highlighting these types of investments. Here are a few of my favorites:
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