Micro Blog #6: How To Decide Between Low vs. High Yielding Stocks

Some experts say it's better to own a higher dividend growth stock than a low dividend growth stock as the high yield is likely a sign of a higher risk.

But what if the risks are the same as there are high quality blue chip stocks that are also the high yielders? Many of the blue chip utilities/telecom and REITs would fall under this group, especially as the increasing interest rates drive their yields higher.

If you have to pick between say T (AT&T) yielding a 5.3% yield with only 2% annual dividend growth and HRL (Hormel Foods) with 2.2% yield and 10% annual dividend growth? Which one would you pick and why?

This is what I would do. I would look at my objectives first, which is to earn more cash flow or income from my investments in a period of about 10 years. The more cash I earn now in dividends, the more of it can go to generate even more dividends in future by re-investing.

I picked a 10 year period as it is more realistic for me in terms of making forward estimation on income needs, while keeping lifestyle changes to the minimum. Both of us would likely be retired by that time and would then be using dividends for income.

https://sugar.mhinvest.com/highcharts/investment.php

The dividend growth calculator shows me that it would take 21 years for the dividend income from HRL to catch up to the dividend income I would have collected and re-invested from T.

That's 21 years folks, do you know where you would be in 10 years, let alone 21 years? I sure don't.

Of course, HRL stock price may grow faster than T, but there is no guarantee that HRL dividend growth can maintain 10% rate for the next 21 years. A lot can happen in 21 years.

Whereas with T, I'm locking in a 5.3% yield at today's price, it's pretty much guaranteed. This is what I would earn on my invested money plus the 2% dividend increase each year. A 2% annual increase is more sustainable than a 10% or a 15% annual dividend increase over the next 10 years. Think about it!

It all comes down to knowing your objectives and time period. If your objective is to earn higher income in a shortest period of time than T may be a good fit for you, whereas if you are looking for a higher stock price growth and don't mind waiting for a very long time for income to grow then HRL may be an excellent choice for you.

Personally, I like my portfolio to be overweight in high yielding blue chip stocks than low yielding stocks. It allows me higher current cash flow that can be reinvested to generate even more cash to meet my 10 year income target.

Disclosure: I'm long T


Comments

  1. I think what's key is checking out where the payout ratio is on a particular stock. T may have a higher yield but if they're already paying out 90%+ of their earnings then they're unlikely to grow it at anything more than 2% and may even stop growing if there's some earnings pressure.

    A 2% yielder that's currently paying 20% of their EPS may have more upward potential since it's got more room to invest and fuel growth AND grow their dividend in the future.

    ReplyDelete
    Replies
    1. That’s a good and valid point. However payout ratios can change over time both in a good and bad way due to change in earnings. For example T has reduced its payout ratio to 68% as of FY 2017 and expect to be in high 50% in 2018. So T could become a high DGR stock in future while HRL could suffer eps decline and slow down its DGR.

      So we really don’t know what will happen in future, but what we know is what we are locking down in yield today and 2% DGR is more sustainable moving forward.

      Based on today’s information and knowing my objectives l can make an educated guess on which investment will earn me more income in my target time period.

      Delete
  2. Mr. ATM, It is the never ending balance of the dividend growth stock investor. I think you say it right that it should come down to one's investment objectives. Question: Do you believe the faster growing dividend will produce greater capital appreciation than it's slower growing counterpart and thus greater total returns? Tom

    ReplyDelete
    Replies
    1. Tom, yes l do believe that low yielding but faster dividend growth stocks tend to have higher total returns over a very long period of time.

      Reason being, the compounding affect of their high DGR takes many more years to generate large sums of income compared to a high yielding stock where more cash is put to work early on.

      The other reason of course is the low yielders tend to be more high growth companies which helps their stock price.

      Given my objectives and time period, l use low yielders as a source for raising capital for more income. When a high yielder becomes a low yielder, l would have big cap gains which l can harvest and apply to higher yielding stocks, thus increasing my income without requiring new capital.

      So there is a use for both high and low yielding stocks in a DGR portfolio.

      How to balance between the two, depends on your investment objectives and target time period. At least that’s how l see it.

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