Dividend Yield vs. Dividend Growth

When I first started learning about stocks I was drawn towards investing in companies that pay dividends.  As I researched more about dividend stocks I wondered why anyone would invest in a stock that paid a lower dividend yield than their competitor.  I clearly did not understand dividend yield vs. dividend growth.

High Dividend Yield

I began identifying high dividend yield stocks and even gravitated towards the Dogs of the TSX approach to investing.  This is where you purchase the 10 stocks in the S&P/TSX 60 with the highest dividend yield, hold them for a year, and then replace them with the new list of 10 high yielding stocks.

This strategy was a variation of the Dogs of the Dow approach that was invented by the U.S. stockbroker Michael O’Higgins, and it has performed quite well over the last few decades.  The problem I had with the strategy is that I didn’t want the constant turnover in my investment portfolio; I wanted something I could hold for the long term.

The other issue with investing in companies with a high dividend yield is trying to determine if the dividend is at risk of being cut or eliminated.  High dividend yielding stocks have often been beat-up due to poor earnings or a change in their business, hence the name “dogs of the TSX”.  A company like Yellow Media has an extremely high dividend yield, but it will be nearly impossible for them to sustain their dividend while earnings continue to fall.

High Dividend Growth

So if high yield alone is not a good enough measure to determine which dividend stocks to own, what else can investors look at?  Dividend growth investors are looking for stocks that can consistently raise their dividends over time.  There are a few ways that investors can use to determine the best dividend growth stock.

  1. Dividend Aristocrats – Stocks that have increased their cash dividends every year for the past 5 years are considered to be dividend aristocrats.  The Claymore Dividend ETF (TSX: CDZ) tracks this index, so a good starting point to find dividend growth would be to research their individual holdings.
  2. Average Dividend Growth Rate – Some stocks don’t raise their dividends every year but can still be considered dividend growth stocks due to a high dividend growth rate over a longer period of time.  For example, the Canadian banks did not raise their dividends for a few years during the global economic crisis, but their 5 year average dividend growth rates were still respectable.
  3. Low Yield, High Growth – The stocks that often get ignored by dividend growth investors are the low yield, high dividend growth stocks.  Stocks like Shoppers Drug Mart (TSX: SC) have a low initial yield of 2.4%, but their average dividend growth rate is over 17% per year over the last 5 years.  Similarly, CN Rail (TSX: CNR) has a current dividend yield of 1.6%, but boasts an impressive 16% average dividend growth rate over the last 5 years and has increased their dividend for 14 consecutive years.

Chasing Yield

It’s important for dividend investors to remember that the search for yield does not simply mean chasing the highest yield in the market.  Often times there are warning signs that accompany stocks with high yields and unsustainable dividend payout ratios.

Broaden your scope of research to include stocks with a high dividend growth rate.  Even though their initial yield may be lower, they tend to be above average companies that deliver above average returns over time.  This keeps the stock price high and the current dividend yield low; meanwhile you collect the growing dividends while increasing the return on your initial investment.

Written by Robb Engen

Robb Engen writes about Canadian personal finance at Boomer & Echo. Together with his mom, (she’s the Boomer, he’s the Echo) they offer their own unique perspectives on saving, investing and personal finance.

13 Responses to Dividend Yield vs. Dividend Growth

  1. I think you hit the nail on the head. Dividend growth and sustainability over time is much more important than a single instance of a high yield because the stock price is so low.

  2. TJ says:

    I try to find a combination of the two, both reasonably high yield and good growth.

    Your example of CNR, for example, has recent high growth. But at 1.6% current yield, it would take 9 years at 16% growth to reach what AT&T is already delivering. And that’s not accounting for reinvesments of the 6% for 9 years.

    The other advantage of the dogs is that the stock price is beaten down (thus the high yield) which means a pretty good chance of capital growth too.

    But your point is well taken, looking at growth is important – and chasing yield is very bad.

    • Echo says:

      @Brave New Life – You’re right, a middle ground would be to find a dividend growth stock yielding 3 to 4 percent.

      That said, I believe the theory that the dividend growth rate of a company will be equal to the total return from the stock eventually.

      Some stocks (like CNR) have a high dividend growth rate and their stock price should appreciate at the same rate over time, which keeps the initial dividend yield down.

    • samsondondon says:

      any body got the idea of where to meet younger single Chinese women?

    • Somebody tell me when Iphone6 come?

  3. A typically great post from Echo! You’re right, a good yield is always appealing, but the history of growth means your compounded results overtime will shine, and it also says a lot about the financial health of the company.

    • Echo says:

      @My University Money – Thanks for the kind words. The ability to pay increasing dividends over time definitely speaks to the financial health of the business.

  4. The Wealthy Canadian says:

    Great post!

    Nice idea to list Claymore’s CDZ to get quick access to the aristocrats.

    I think you really hit it home with point #3, in that there are a lot of great low-yielding dividend plays that offer impressive long-term capital appreciation AND have solid dividend growth rates.

    Take Saputo Inc. (SAP). Earlier this month they announced an 18.8% increase in dividends and their long-term chart speaks for itself.

    • Echo says:

      @TWC – Thanks! Given my long investing time horizon I think I’ll be paying more attention to the lower yield / higher dividend growth stocks.

      And yes, CDZ is a great place to start your research.

  5. Renee says:

    Bear with me, I’m still learning….
    You said “there are warning signs that accompany stocks with high yields and unsustainable dividend payout ratios”.
    What are some of these warning signs?

  6. Xavier says:

    In the light of recent financial crisis I would like to say that dividends are not as secure as they are considered by investing community.Even non-financial companies such as GE were forced to slash their dividends because of economic turmoil.So, an investment decision must not be made only on the basis of dividend yield.

  7. Dividend Yield vs. Dividend Growth

  8. Generally I don’t read article on blogs, but I would like to say that this write-up very pressured me to try and do it! Your writing taste has been surprised me. Thanks, quite nice article.

Leave a reply

Notify me of followup comments via e-mail. You can also subscribe without commenting.

Name: Email: