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10 by 10: A New Way to Look at Dividend Yield and Growth
by David Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
December, 2008
Dividend investors often set minimum requirements for an “acceptable” initial
dividend yield and/or dividend growth rate when they are considering buying a
dividend stock.
Thus one investor might say, “I won’t invest in a dividend stock with a starting
yield less than 3%.” Another might say, “I want a minimum 10% per year
dividend increase.” A third might require that a stock has grown its dividends
for 10 or 15 or 25 consecutive years.
In dividend investing, the goal is to purchase stocks whose yields and dividend
growth rates combine to make them better bets than safer fixed-income
investments like money market accounts, certificates of deposit, and bonds.
The dynamic that determines the long-term dividend return of a dividend-paying
stock is the interplay between the stock’s initial yield and its annual dividend
growth rate. Obviously, a 5% initial yield will require a lower annual growth rate
than a 3% initial yield to achieve a given return within a given time. Conversely,
the lower-yielding 3% stock will catch up to and pass the return of the 5% stock
if it has a higher annual rate of growth in its dividend payouts.
Most dividend investors have a long-term holding period in mind when they buy
dividend stocks. They are not looking to trade them often, but rather to hold
them, allowing time for the dividends to increase and compound, until the stock
itself becomes a money-generating machine irrespective of the stock’s price
fluctuations.
Here is a useful way to look at this: Seek stocks that will achieve a 10%
dividend return on your original investment within 10 years’ time. I call this the
10 by 10 approach.
The two 10’s are arbitrary, of course. You can put in any goals you like. I
chose 10 and 10 because:
• 10% is a healthy rate of return, almost equal to the long-term total return
of the stock market itself. (Most studies put that total return at between 10%
and 11% over long time frames. Total return includes price appreciation as well
as dividend return.)
• 10 years is a useful time frame for people of most ages. Young people, of
course, have a much longer investment horizon, but nevertheless they may
consider 10 years long enough to wait for the return they ultimately want. Older
people—say in their 60’s and 70’s—still often think in terms of time periods at
least as long as 10 years, since just by having lived to their current age, their life
expectancy usually is longer than 10 years from right now.
• And, of course, 10 is a nice round number. It is easy to think in terms of
10% return and a 10-year time frame to get a good grasp of the underlying
principles.
So the question becomes simple math: What initial yields, compounded at what
rates of growth, achieve 10% return within 10 years?
The following table answers that question. It shows initial yields (across the top)
and annual growth rates (down the side). Where any two values intersect, the
table shows how many years it takes to achieve a 10% dividend return.
10 by 10 Table for Dividend Investors
Annual Initial Yield
Growth 2% 3% 4% 5% 6% 7% 8% 9% 10%
Rate
4% 40 30 23 17 12 8 5 2 1
5% 32 25 18 14 10 8 4 2 1
6% 27 19 15 12 8 6 3 1 1
7% 24 17 13 10 7 5 3 1 1
8% 21 15 12 9 6 4 3 1 1
9% 19 14 11 8 6 4 2 1 1
10% 17 13 10 7 5 4 2 1 1
11% 15 12 9 7 5 3 2 1 1
12% 14 11 8 6 5 3 2 1 1
13% 13 10 8 6 4 3 2 1 1
14% 12 9 7 5 4 3 2 1 1
15% 12 9 7 5 4 3 2 1 1
Notes:
1. The table ignores the contribution of price increases. It shows only the
rate of return based on increases in the dividend over time.
2. The rates of dividend increases should be considered average annual
rates. It is rare for a company to increase its dividend by the same percentage
amount each year.
3. The table does not include the accelerating effect of reinvesting the
dividends, which would shorten the times shown. It just shows the increase in
your yield from growth in the dividend itself.
4. In calculating the table’s values, all years were rounded to the nearest
year that a 10% return (from dividends alone) would be achieved. Thus all
years appear as whole numbers.
5. Returns were also rounded, so the year that a return reached 9.6% was
counted as the year it hit 10%.
6. The “sweet spot” wherein the 10 by 10 goal is achievable has been
shaded in red. So, for example, a 4% initial yield growing at 10% per year
achieves the same result as a 5% initial yield growing at 7% per year: Both
reach a 10% return (from the dividend alone) in about 10 years.
A couple of interesting conclusions jump out from this table.
First, a 2% initial yield cannot reach the 10 by 10 goal at any rate of increase up
to 15% per year. “You can’t get there from here.”
Second, the table demonstrates that the initial yield is somewhat more important
than the rate of dividend growth. For example, a mere 1% additional initial yield
reduces the growth rate needed to reach the 10 by 10 goal by 2% to 4% per
year. In the example cited earlier (see number 6 above), a jump in initial yield
from 4% to 5% reduced the dividend growth rate needed to achieve the 10 by
10 goal by 3% per year.
This latter point is important. The faster you hit your 10% dividend return rate
goal, the fewer years that your stock choice is subject to prediction risk—that is,
the risk that you overestimated its rate of dividend growth. As all dividend
investors know, their initial rate of return is fixed at the time of purchase, but
the future rate of dividend growth is somewhat speculative. Besides that, the
higher the rate of projected dividend growth, the more risk that it will not
actually be achieved. Getting to your goal in fewer years is generally better all
around.
That said, beware of extremely high initial yields. Yields of 10% or more are
often red flags that the company is in trouble (its stock price has plummeted,
creating the high yield) or that its dividend may be at risk. So besides seeking a
high initial yield and "enough" growth rate, be sure to do your normal due
diligence on the company's Story, its financials, its competitive outlook, and the
like.
As stated earlier, investors with other goals may plug in different numbers
besides the 10 and 10 that I selected. Maybe you want to achieve 12% dividend
yield within 9 years, or 10% yield within 7 years. It is easy to modify the table
to show the combinations of initial yield and dividend growth rate you need to
achieve those goals. The underlying principles remain the same.
by David Van Knapp, author of
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
and
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
December, 2008
Dividend investors often set minimum requirements for an “acceptable” initial
dividend yield and/or dividend growth rate when they are considering buying a
dividend stock.
Thus one investor might say, “I won’t invest in a dividend stock with a starting
yield less than 3%.” Another might say, “I want a minimum 10% per year
dividend increase.” A third might require that a stock has grown its dividends
for 10 or 15 or 25 consecutive years.
In dividend investing, the goal is to purchase stocks whose yields and dividend
growth rates combine to make them better bets than safer fixed-income
investments like money market accounts, certificates of deposit, and bonds.
The dynamic that determines the long-term dividend return of a dividend-paying
stock is the interplay between the stock’s initial yield and its annual dividend
growth rate. Obviously, a 5% initial yield will require a lower annual growth rate
than a 3% initial yield to achieve a given return within a given time. Conversely,
the lower-yielding 3% stock will catch up to and pass the return of the 5% stock
if it has a higher annual rate of growth in its dividend payouts.
Most dividend investors have a long-term holding period in mind when they buy
dividend stocks. They are not looking to trade them often, but rather to hold
them, allowing time for the dividends to increase and compound, until the stock
itself becomes a money-generating machine irrespective of the stock’s price
fluctuations.
Here is a useful way to look at this: Seek stocks that will achieve a 10%
dividend return on your original investment within 10 years’ time. I call this the
10 by 10 approach.
The two 10’s are arbitrary, of course. You can put in any goals you like. I
chose 10 and 10 because:
• 10% is a healthy rate of return, almost equal to the long-term total return
of the stock market itself. (Most studies put that total return at between 10%
and 11% over long time frames. Total return includes price appreciation as well
as dividend return.)
• 10 years is a useful time frame for people of most ages. Young people, of
course, have a much longer investment horizon, but nevertheless they may
consider 10 years long enough to wait for the return they ultimately want. Older
people—say in their 60’s and 70’s—still often think in terms of time periods at
least as long as 10 years, since just by having lived to their current age, their life
expectancy usually is longer than 10 years from right now.
• And, of course, 10 is a nice round number. It is easy to think in terms of
10% return and a 10-year time frame to get a good grasp of the underlying
principles.
So the question becomes simple math: What initial yields, compounded at what
rates of growth, achieve 10% return within 10 years?
The following table answers that question. It shows initial yields (across the top)
and annual growth rates (down the side). Where any two values intersect, the
table shows how many years it takes to achieve a 10% dividend return.
10 by 10 Table for Dividend Investors
Annual Initial Yield
Growth 2% 3% 4% 5% 6% 7% 8% 9% 10%
Rate
4% 40 30 23 17 12 8 5 2 1
5% 32 25 18 14 10 8 4 2 1
6% 27 19 15 12 8 6 3 1 1
7% 24 17 13 10 7 5 3 1 1
8% 21 15 12 9 6 4 3 1 1
9% 19 14 11 8 6 4 2 1 1
10% 17 13 10 7 5 4 2 1 1
11% 15 12 9 7 5 3 2 1 1
12% 14 11 8 6 5 3 2 1 1
13% 13 10 8 6 4 3 2 1 1
14% 12 9 7 5 4 3 2 1 1
15% 12 9 7 5 4 3 2 1 1
Notes:
1. The table ignores the contribution of price increases. It shows only the
rate of return based on increases in the dividend over time.
2. The rates of dividend increases should be considered average annual
rates. It is rare for a company to increase its dividend by the same percentage
amount each year.
3. The table does not include the accelerating effect of reinvesting the
dividends, which would shorten the times shown. It just shows the increase in
your yield from growth in the dividend itself.
4. In calculating the table’s values, all years were rounded to the nearest
year that a 10% return (from dividends alone) would be achieved. Thus all
years appear as whole numbers.
5. Returns were also rounded, so the year that a return reached 9.6% was
counted as the year it hit 10%.
6. The “sweet spot” wherein the 10 by 10 goal is achievable has been
shaded in red. So, for example, a 4% initial yield growing at 10% per year
achieves the same result as a 5% initial yield growing at 7% per year: Both
reach a 10% return (from the dividend alone) in about 10 years.
A couple of interesting conclusions jump out from this table.
First, a 2% initial yield cannot reach the 10 by 10 goal at any rate of increase up
to 15% per year. “You can’t get there from here.”
Second, the table demonstrates that the initial yield is somewhat more important
than the rate of dividend growth. For example, a mere 1% additional initial yield
reduces the growth rate needed to reach the 10 by 10 goal by 2% to 4% per
year. In the example cited earlier (see number 6 above), a jump in initial yield
from 4% to 5% reduced the dividend growth rate needed to achieve the 10 by
10 goal by 3% per year.
This latter point is important. The faster you hit your 10% dividend return rate
goal, the fewer years that your stock choice is subject to prediction risk—that is,
the risk that you overestimated its rate of dividend growth. As all dividend
investors know, their initial rate of return is fixed at the time of purchase, but
the future rate of dividend growth is somewhat speculative. Besides that, the
higher the rate of projected dividend growth, the more risk that it will not
actually be achieved. Getting to your goal in fewer years is generally better all
around.
That said, beware of extremely high initial yields. Yields of 10% or more are
often red flags that the company is in trouble (its stock price has plummeted,
creating the high yield) or that its dividend may be at risk. So besides seeking a
high initial yield and "enough" growth rate, be sure to do your normal due
diligence on the company's Story, its financials, its competitive outlook, and the
like.
As stated earlier, investors with other goals may plug in different numbers
besides the 10 and 10 that I selected. Maybe you want to achieve 12% dividend
yield within 9 years, or 10% yield within 7 years. It is easy to modify the table
to show the combinations of initial yield and dividend growth rate you need to
achieve those goals. The underlying principles remain the same.
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