When investing in a company for dividends, there are two basic data points that I use to filter interesting companies – dividend yield and dividend growth. The dividend yield tells me how much return I’m going to get from the investment made in that company, and the dividend growth will show the potential of that return to grow over time.
For example, the Alef (imaginary) company trades on the TASE, has a dividend yield of 5% and an annual dividend growth of 10%, this is how the dividend of my investment will grow after an initial investment of 100 NIS, reinvesting of all dividends.
After 20 years, our initial investment of 100 NIS that initially distributed 5 NIS has turned into a dividend of almost 35 NIS, which is about 700% growth.
We can also take a look at the total return, which for me is something less important because the price of a stock is partially based on company fundamentals but also based on market sentiment, even more now that many investors use indexing. So I’m assuming here that the price of the stock is constant. I know this is a very strange assumption but it lets us compare things more easily.
My initial investment of 100 NIS becomes 390 NIS in 20 years. That’s the magic of dividend growth and compounding at work.
What would happen if we had less dividend growth? Let’s switch the values so that my stock now has an initial dividend yield of 10%, but a yearly growth of 5%.
After 20 years my dividend is now about 27 NIS, lower that before but still a nice growth of 270%. But if we take a look at the total value, things get more interesting.
In this case, the initial high dividend yield gives a push to the total value that mitigates the lower dividend growth, giving us a total return of 435 NIS, which is higher than before, but as I’m simulating a constant price, this comparison is just “academic” and not real.
Checking all possible dividend yields/growth options is impossible, but I wanted to do a bit more comparisons, so I compared 3 scenarios – initial yield of 2.5, 5%, 10%, 15%, and 20%, with growth of 20%, 15%, 10%, 5%, and 2.5% respectively.
In the “short” term (~10 years), high initial yield distributes more dividend, after which the lower initial yield but higher growth start passing it and in the next 12 years the lowest initial yielder becomes the one with the highest distribution, almost 4 times the final distribution of the lowest dividend grower.
As for the total value, it takes a lot more time for the higher dividend growth stocks to “catch up” to the total value of the dividend yield stock (17 years). After ~20 years another dividend growth stock also catches up, and if we gave it more time all dividend growth stocks would pass the high initial yielder.
So what can we learn from this?
First, comparisons are hard :-). There are many different variables to compare and each one behaves differently, so we can only do controlled simulations and decide hoping that the world will behave more or less close to the simulation.
Second, in the short term, a high yield will give higher dividend, and also higher total return, but in the longer run (20+ years), dividend growth always wins, both in actual yield and in total return.
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