My First Major Dividend Growth Investing Revelation

Since I began dividend growth investing in September 2017, I've primarily been an investor that focuses more on yield than on dividend growth. While I own plenty of companies with high dividend growth, such as Home Depot (HD), Lowe's (LOW), and Williams Sonoma (WSM), it's no secret that my portfolio is chalk full of companies with high dividend yields and low single-digit dividend growth or maybe even no growth, such as AT&T (T) and Royal Dutch Shell (RDS.B). Recently, I've come to see the value in low yield, high growth companies, such as Visa (V), TJX Companies (TJX), and Lockheed Martin (LMT).


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As I've grown older and more experienced as an investor, and as my dividend income has continued to grow, I've become less fixated on yield and more focused on the dividend growth aspect of investing. After all, it's the dividend growth of a portfolio that helps an investor crush inflation and build long term wealth that can be generational.

While I believe it's important to own high yielding companies like AT&T, I'd argue it's equally as important to own low yielding, high growth dividend companies.

The case for an investment in companies like AT&T is obvious. The higher amount of current income one receives, the more they can reinvest, which acts as one of the three growth mechanisms for dividend income, with the other two being dividend increases and fresh capital contributions.

At the time of writing, AT&T offers a 6.31% dividend yield and ~2% dividend increases each year, which will probably accelerate to 3% a year once AT&T has completed its deleveraging plan. For the sake of calculation purposes, we'll assume that 2% dividend increases continue to be the norm. According to BuyUpside's dividend payback period calculator, it would take 14 years for one to recover their initial investment in dividends from AT&T, which they could also reinvest in other attractive buying opportunities along the way. While investors with a 30, 40, or 50+ year time span are better off with a low yielding company, high growth company like Visa, it's quite easy to see why high yielders with reasonably sustainable dividends like that of AT&T received my preference for the past two years, and why companies like AT&T are crucial to a dividend investor.

At the time of writing, Visa offers a 0.59% dividend yield and the potential for 16% dividend increases each year for the next couple decades due to its lucrative, high growth business, and low payout ratio. If we assume a very conservative 12% CAGR for earnings over the next 20 years, Visa could increase its dividend each year by 16% and its payout ratio would double from 19% to a still manageable ~38%. Before we plug in how long it would take to recover an investment in Visa in dividends, I'd like you to estimate how long it would take for this to occur.

If you properly considered the power of compounding dividends, you would have replied it would take 22 years to recover your investment in Visa.

When we consider that Visa's starting yield is less than a tenth of what AT&T's is, this is absolutely mind boggling and I never gave enough merit to companies like Visa until I was configuring a model dividend growth with a 3.3% yield, a 9% 5 year DGR, and a 8% 10 year DGR. I found that companies like Visa were like adding gasoline to the dividend growth fire, so to speak.

Even if we assume AT&T manages to achieve a long-term dividend growth rate of 3%, the yield on cost of AT&T after 25 years barely doubles from the current 6.31% to 12.83%, using the yield on cost calculator.

If we take Visa and plug in an even more conservative dividend growth rate of 14% a year over the next 25 years, we arrive at a monstrous yield on cost of 13.70% from the current 0.59%.

While I always understood the power of compounding dividends, I never truly understood it until I stopped and took a few moments to analyze what a comparison like the one above looks like in action.

Admittedly, there may be flaws in the above long-term projections (AT&T's long-term dividend growth could be 3-4%, and Visa's could be a bit lower than the 14% over the next 25 years), but I think the illustrative nature of this example could help other investors to let go of their shortsightedness and fixation on yield like I recently did.

I've always been a long-term thinker, but until I did this experiment, I would typically only think about 5 years from now or 10 years from now. Sure, it may be difficult to predict what the future holds two decades from now for AT&T and Visa, but it's quite enlightening to see that each company holds its own purpose in a DGI portfolio.

It is my hope that the above demonstration will prevent others from chasing yield too often like I did in the past. It's understandable for one to question "how can I increase my dividend income faster" when one is just starting out and they receive their first dividend check for a few dollars like the $1.35 I received from Genuine Parts Company in October 2017.

But I believe as one continues to invest and their dividend income grows, they feel less of a need to chase yield and they start to include high growth dividend payers in the mix. This is my perspective as a relatively new investor, and I'm thrilled to share with readers how my overall thoughts on DGI change as I become a more experienced investor.

Discussion:

Did you have a tendency to chase higher yields when you first began dividend investing? Or were you already well aware of the power of rapidly growing dividends? As always, thanks for reading and I look forward to replying to your comments.