Dividend Yield Vs. Dividend Growth

The age old question, should we be investing for dividend growth or dividend yield?

I don't know if my thinking is a little off, but here is my argument (well it's a weak argument, but that's because I'm tired). You may be surprised by the conclusion I'll ultimately reach on this subject.

I'd rather invest for dividend yield over dividend growth but my favorite strategy lies somewhere in the middle. I assume most stocks that operate under a high dividend yield, do so for one of several reasons: The share price has recently dropped (due to bad news? poor outlook?), it might be a risky business, or it could be an old ‘out of favor' cash cow. Either way, I would never invest in a company that isn't solid and at least growing modestly. So that should filter out a bunch of high yield stocks, but not all.

A company that has a high dividend yield, at one time or another, probably (key word) raised its dividend and as such could be considered a dividend growth stock. It might be a poor dividend growth stock, but growth is growth.

Now here is where my real argument comes into play. Let's pit dividend growth investor against dividend yield investor with two hypothetical situations (to which I will undoubtedly craft the story to validate my theory) and see who comes out ahead.

Dividend yield investor finds a stock with a 13.00% yield. Dividend growth investor finds a stock with a 2.00% yield and an average annual dividend growth rate of 10%. Guess how long it will take before the dividend yield stock is paying out even 5%? 10 years! That is ten years of getting ~11% less per year in dividend returns!

Yes, I realize that the dividend growth company probably has some capital gains, but so can the dividend yield stock! Now if was the exact same company under two different scenarios (had the company went with two different structures) I'd rather own the dividend yielding one. This allows me to get some money on a regular basis and decide where to put it. There are some tax reasons I really enjoy dividends as well. Heck, I won't even finish the story.

I've picked several very high dividend yield companies that have a history of not only increasing the dividend but also increasing the share price! Some have more than doubled in share price (within 2 years) while raising dividends and giving out a ~10% to ~14% dividend yield. Technically, it was a high dividend yield growth stock (my favorite). I could invest in a company that will take 20 years to raise its dividend to a high level (based on the original purchase price) but I'd rather stick my money in places where it will start making me money now. This money will earn a higher rate of return and then allow me to choose other high yield growth opportunities to invest in along the way.

Who wins in Dividend Yield vs. Dividend Growth… neither. If the same company was hypothetically put into two different business structures, the net result would be fairly similar… Yes, there are tax implications… but overall, we'd still be talking about the same company (perhaps a bit more sluggish and sloppy due to its extra cash horde… or smaller and more efficient if it gave away extra profits). The biggest difference is the dividend yield investor would have had an opportunity to use his higher dividend profits (as long as he doesn't waist them) to retire or grow the investment portfolio. Many folks that plan on retiring simply don't have the time to wait for a dividend growth stock to make its original 2% dividend yield high enough to live off of. Plus, management often get a whole lot more creative and result oriented when they don't have a ton of extra cash… the company that gave out all the dividends would undoubtedly have less assets, but it might not suffer as much as you think. A lot of companies have a core product or service that is their primary cash cow and, in order to grow, management tries to launch new products, of which most fail or never reach the same level of profitability as the core ones. This money, if given to the investor, allows him to invest in other companies with profitable cores… paper profits don't seem as appealing as profits that are allowing me to retire or re-invest each month…

The real question is, why is there a debate about dividend yield vs dividend growth at all? The answer should be simple… Dividend Yield + Dividend Growth = Win!