Dividend Growth vs High Yield Investing
Dividend Growth vs High Yield Investing. I have written several in depth articles about the benefits of dividends to investors. You can read the article on Why Dividends Matter To Investors for the details but to summarize: dividends are in indicator of financial health for a company, dividend make up a significant percentage of total return, dividend growth stocks have lower volatility, dividends provide downside protection during a declining market, and lastly qualified dividends are taxed at lower rates than your regular income. But there is more than one way to invest in stocks that pay dividends and that often comes down to dividend growth vs high yield investing.
There are two main flavors of dividend investing: dividend growth investing, which I am an avid believer, and also high yield investing. Is one of these strategies more correct or more wrong. I would argue no, a lot depends on your circumstances including your age, income needs, and time to financial independence or time to retirement. So, let’s compare dividend growth vs high yield investing.
Dividend Growth vs High Yield Investing – Which is Better?
High Yield Investing
If you have need of income from dividend stocks in the next few years, such as during retirement, then dividend growth investing is likely not the right answer for you. In this case you are more likely looking for a high yield strategy since your income needs are much more immediate.
But my observations indicate that there are challenges for a high yield investing strategy if not followed properly. Investing lessons from the COVID-19 pandemic demonstrated dividend safety and quality is paramount. First and foremost, high yields can be an indicator that a company is performing poorly. The yield rises as the stock prices drops when a company is not meeting expectations. You do not have to look far for examples in the recent past including Exxon Mobil (XOM), AT&T (T), International Business Machines (IBM), and Walgreens Boots Alliance (WBA). In some cases, the poor performance is temporary and transient but in other cases the dividend safety may drop to a point where the dividend is cut or suspended.
There are stocks that have structurally high yields since they are required to pay most of their earnings as dividends. This includes real estate investment trusts or REITs and master limited partnerships or MLPs. However, these categories of stocks do not benefit for qualified dividend status.
Dividend Growth Investing
Dividend growth investing is really for those with longer time horizons, but even 50 is not too old to start investing. A dividend growth investing strategy focuses on companies that are growing revenue, earnings, and free cash flow to support a rising dividend over time. These companies may not pay a high yield. Indeed, many have yields below that of the S&P 500. For example, American States Water (AWR) has paid a growing dividend for 66 years but only has a dividend yield of about 1.75% at the moment. Although there are stocks with yields over 3% with long-term and sustained dividend growth. Coca-Cola (KO) comes to mind, which I am long.
The pay off with a dividend growth strategy is in the future. By reinvesting the dividends, you are leveraging the power of compounding over time. This growth can be substantial over time. Furthermore, you can generate a growing passive income stream for the future. The challenge though is that dividend growth investing takes patience and the right temperament.
In the hypothetical example below, I look at an initial investment in Coca-Cola almost 10-years ago. You buy $10,000 worth of shares at $31.57 on February 14, 2011 (pre-split-adjusted) and start with ~316.76 shares. The quarterly dividend is $0.235 per share giving a quarterly cash payout of about $74.44. Assuming you reinvest the dividends, by the end of 2020, you have 431.97 shares at $51.60 per share. Your $10,000 has turned into over $22,284. The quarterly dividend is now $0.41 per share giving a quarterly cash payout of $177.11.
The impressive part is that this is if you did nothing else. Indeed, if you added to your position in regular intervals or on the dips your passive income stream would be higher still. Getting to the first $100,000 is the hardest of course but if you had a few stocks like Coca-Cola it is possible even if you are starting out investing with little money or saving for retirement as a late starter.
Final Thoughts Dividend Growth vs High Yield Investing
Irrespective of the strategy that you follow, dividend safety is extremely important. I check dividend safety based on earnings, free cash flow, and debt. I have had only three dividend cuts in many years of investing. One stock was an MLP, as debt and equity fueled acquisitions made the dividend unsustainable for Kinder Morgan. The second stock was a special situation stock on a spin off and then impacted by the COVID-19 pandemic, KAR Auction Services (KAR). The third stock was due to a change in company management and strategy, J2 Global (JCOM). However, in two the cases I still had a positive return, which mitigated the impact. In any case, always perform your due diligence when you invest.
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Chart or Table of the Week
Today I highlight Tootsie Roll Industries (TR). The stock is well-known to many due to its iconic candy as well as its other brands. Who hasn’t tried a Tootsie Roll, Blow Pops, Charms, Andes, Junior Mints, or one of their other brands as a child? The company has paid a regular cash dividend for many years and the current yield is roughly 1.1%. The dividend is also very safe with 42% payout ratio and over $150 million in net cash position. The yield is not impressive but Tootsie Roll issues a 3% stock dividend annually giving roughly a 4% effective yield. The company has struggled a bit due to the COVID-19 pandemic, but rising vaccination rates should mean a better 2021 and 2022. Tootsie Roll is a Dividend King with 52 years of consecutive annual dividend growth. The screenshot below is from Stock Rover*.
Dividend Increases and Reinstatements
Dividend Cuts and Suspensions List
I updated my dividend cuts and suspensions list at end of March. The number of companies on the list has risen to 518. We are well over 10% of companies that pay dividends having cut or suspended them since the start of the COVID-19 pandemic.
There were no new companies to add to the list this past month (March 2020).
Dow Jones Industrial Averages (DJIA): 33,803 (+1.96%)
NASDAQ: 13,900 (+3.11%)
S&P 500: 4,129 (+2.71%)
The S&P 500 is trading at a price-to-earnings ratio of 42.0X and the Schiller P/E Ratio is at about 37.1X. These two metrics up in the past two weeks. Note that the long-term means of these two ratios are 15.9X and 16.8X, respectively.
I continue to believe that the market is overvalued at this point. I personally view anything over 30X as overvalued based on historical data. Note that we are near or over 40X and valuation levels near the top of the dot-com era.
S&P 500 PE Ratio
Shiller PE Ratio
Stock Market Volatility – CBOE VIX
The CBOE VIX measuring volatility was down this past week to 16.69. The long-term average is approximately 19 to 20. The first time since the pandemic started that the CBOE VIX went below the long-term average was two weeks ago.
Fear & Greed Index
I also track the Fear & Greed Index. The index is now in Neutral at a value of 60. This is up 2 points this past week.
There are seven indicators in the index. They are Put and Call Options, Junk Bond Demand, Market Momentum, Market Volatility, Stock Price Strength, Stock Price Breadth, and Safe Haven Demand.
Junk Bond Demand is indicating Extreme Greed. Investors are accepting 1.99% yield over investment grade corporate bonds. The spread is down further from recent levels indicating that investors are taking on more risk.
Market Momentum is indicating Extreme Greed. The S&P 500 is 10.42% over its 125-day average. This is above the average over the past 2-years. Investors are rotating into stock and the increase has been rapid.
Safe Haven Demand is in Extreme Greed. Stocks have outperformed bonds by 5.80% over the past 20 trading days. This is close to the strongest performance over the past 2-years as investor rotate back into stocks after a period of weakness.
Put and Call Options are signaling Neutral. In the last five trading days, put option volume has lagged call option volume by 58.33%. Put buying is decreasing.
Market Volatility is set at Neutral. The CBOE VIX reading of 16.698 is a neutral reading.
Stock Price Strength is signaling Extreme Fear. The number of stocks hitting 52-week highs compared to those hitting 52-week lows is at the lower end of its range.
Stock Price Breadth is indicating Extreme Fear as advancing volume is 5.17% more than declining volume on the NYSE. Market breadth is improving.
The U.S Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey, or JOLTS reported that job openings increased by 268,000 to 7.4 million in February. The job openings rate is little changed at 4.9%. Increases came in health care and social assistance (+233,000); and accommodation and food services (+104,000). Decreases came in state and local government education (-117,000); educational services (-35,000); and information (-34,000). All regions reported increases – Northeast (+112,000), South (+93,000), Midwest (+34,000) and West (+28,000).
The Department of Labor reported that a seasonally adjusted 744,000 people filed first-time jobless claims for the week ending April 3rd, an increase of 16,000 over the previous week’s revised (+9,000) 728,000 level. The 4-week moving average increased slightly to 723,750 over the previous week’s revised (+2,250) 721,50 level. California (145,367) and New York (67,309) were top contributors to the increase.
The U.S. Bureau of Labor Statistics reported the producer price index (which measures inflation before it reaches consumers) rose a seasonally adjusted 1% in March, and follows a 0.5% increase in February. The PPI over the past 12 months has climbed 4.2%, the largest increase since September 2011’s 4.5%, and follows a 2.8% advance in February. Over one-fourth of the increase in the index for final demand goods can be traced to an 8.8% surge in gasoline prices. Prices for final demand less foods, energy, and trade services rose 0.6% in March and is up 3.1% over the past 12 months
Thanks for reading Dividend Growth vs High Yield Investing – Dividend Power Week in Review!
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If you are unsure on how to invest in dividend stocks or are just getting started with dividend investing. Take a look at my Review of the Simply Investing Report. I also provide a Review of the Simply Investing Course. Note that I am an affiliate of Simply Investing.
If you are interested in an excellent resource for DIY dividend growth investors. I suggest reading my Review of The Sure Dividend Newsletter. Note that I am an affiliate of Sure Dividend.
If you want to simplify your portfolio management and stop using spreadsheets take a look at my article on Passiv – A Modern Portfolio Management Website Review. Note that I an affiliate of Passiv.
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.