10 by 10: The Interaction of Dividend Yield and Growth

One of the most-referenced articles I have published is the original 10 by 10 method for understanding the interplay between dividend yield and dividend growth. I thought it would be good to update that article, introduce the concept to a new generation of dividend investors, and add a couple of new features. There is a lot of discussion about the relative merits of high or low initial dividend yields (IY) compared to high or low dividend growth rates (DGR). Often this discussion comes up when someone says that he or she wants to find a “Dividend Champion of the Future”. The person is willing to accept a low initial yield if the company is relatively young and is raising its dividend very fast. At the opposite end of the spectrum, other investors state that they want high yields now and are willing to accept slower rates of growth (or even no growth, as would be the case with preferred stocks). Which is better? A stock yielding 2.5% but raising its dividend 20% per year, or a stock yielding 8.5% but increasing it at only 1% per year? There is really no “correct” answer - it depends on your goals, which in turn probably turn on factors like your age, your timeframe, and what your current level of income generation actually is. Most people instinctively understand that a low initial yield compounding at a very fast rate will eventually surpass a higher yield that is hardly increasing at all. There will be a crossover point. For example, a 3% initial yielder with a DGR of 20% per year will at some point permanently surpass the dividend return of a 5% initial yielder with a DGR of 5% per year. The question becomes, when do those lines cross? And as an investor, are you comfortable with how long that takes, or do you even care? Once they cross, of course, the initial lower yielder will be generating more annual income dollars than the initial higher yielder, and the gap will increase as the years pass. The original 10 by 10 article provided a way to visualize the interaction of initial yield and DGR. It was based on the fact that the long-term dividend return of a stock is a function of how its initial dividend yield (that is, the yield at the time you buy it, or IY) combines with its annual dividend growth rate (DGR). As a baseline, I selected this scenario: Let’s say that your goal is to build a portfolio whose return on your original investment - your “yield on cost” - will reach 10% within 10 years' time. I call this the "10 by 10" approach. It is the goal that I use in my own Dividend Growth Portfolio.... Read more