{"id":40276,"date":"2013-07-23T14:54:53","date_gmt":"2013-07-23T18:54:53","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=40276"},"modified":"2013-07-23T14:54:53","modified_gmt":"2013-07-23T18:54:53","slug":"forget-yield-dividend-growth-is-the-metric-that-matters","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/07\/23\/forget-yield-dividend-growth-is-the-metric-that-matters\/","title":{"rendered":"Forget Yield; Dividend Growth is the Metric that Matters"},"content":{"rendered":"

By The Sizemore Letter<\/u><\/a> <\/p>\n

Income investors had a little scare in May and June.\u00a0 Bond prices took a tumble and dragged down assets that have come to be viewed as bond substitutes\u2014including popular dividend-paying stocks, MLPs and REITs.<\/p>\n

Now that the dust has settled and the income markets have regained some semblance of normalcy, let\u2019s take a step back and review the case for income stocks.\u00a0 With the Fed\u2019s quantitative easing eventually coming to an end and with bond yields likely to rise in the years ahead, does it still make sense to look to the stock market for income?\u00a0 Or might investors be better off buying and rolling over a bond ladder to meet their income needs?<\/p>\n

Let\u2019s take a look at the numbers.\u00a0 Consider the options you had as an investor ten years ago.\u00a0 In 2003, the 10-year Treasury yielded 3.97%.\u00a0 We\u2019ll be generous and say 4% to keep the math simple.\u00a0 A million-dollar portfolio invested in Treasuries would have paid out an income of $40,000 in the year you bought it\u2026and ten years later, it still would have paid you $40,000 per year on your original purchase price. (Math purists will point out that the yield to maturity calculation is a little more complicated than that, but it\u2019s close enough for our purposes here.\u00a0 We\u2019ll assume you bought the bonds at par and that capital gains are a moot point.)<\/p>\n

Over the ten year life of the investment, you would have received $40,000 per year.\u00a0 Of course, $40,000 went a lot further in 2003 than it does in 2013, but we\u2019ll get to that a little later.<\/p>\n

Now, let\u2019s do the same math on one of my favorite REITs\u2014Realty Income ($<\/span>O<\/a>).<\/b><\/p>\n

I chose Realty Income for a very specific set of reasons.\u00a0 First, in 2003, its dividend yield\u2014at 3.5%\u2014was close enough to the 10-year Treasury yield to make these two viable competitors for the would-be income investor\u2019s portfolio.\u00a0 Secondly, as a low-risk, triple-net retail REIT, Realty Income is a prime example of a stock that has come to be viewed as a \u201cbond substitute\u201d by income investors.<\/p>\n

So, how did Realty Income stack up?<\/p>\n

The math here is a little more detailed, but I\u2019ll do my best to keep it simple.\u00a0 A million-dollar portfolio invested in Realty Income at the beginning of 2003 would have bought you 29,516 shares paying $1.17 per share in annualized dividends.\u00a0 That works out to $34,534 in income in the first year\u2014or about $5,500 less than the 10-year Treasury.<\/p>\n

But this is where it gets fun.\u00a0 Unlike the bond, Realty Income actually raised its payout every year.\u00a0 By 2013, those 29,516 shares were paying out $2.18 per share in annual dividends.\u00a0 That works out to $64,345 in annual income\u2014or $24,345 more than the interest from the bond.<\/p>\n

In 2013, Realty Income sported a dividend yield of 4.8%, which isn\u2019t shabby.\u00a0 But your yield based on your purchase price would have been a much more impressive 6.45%.\u00a0 And remember, we haven\u2019t said a word about capital gains; we\u2019re focusing purely on the cash payout, which is ultimately what pays your bills in retirement.<\/p>\n

Stepping away from REITs, let\u2019s take a look at two widely-held blue chips that have more or less tracked the market over the past ten years\u2014Johnson & Johnson ($<\/span>JNJ<\/a>) <\/b>and Wal-Mart ($<\/span>WMT<\/a>).<\/b>\u00a0 I included both of these names for one critical reason\u2014both paid comparably low dividends back in 2003.\u00a0 Yet despite paying a modest yield at the time, both had been serial dividend raisers for a long time\u2014and still are.\u00a0 Their stock prices have had wild swings over the years, but their dividends have been a source of rock-solid stability.<\/p>\n

In 2003, Johnson & Johnson and Wal-Mart yielded 1.5% and 0.65% in dividends, respectively.\u00a0 A million dollars invested in each would have paid out $15,296 and $6,538.\u00a0 That stacks up pretty poorly in comparison to the $40,000 you could have received in bond interest by investing in Treasuries.<\/p>\n

But let\u2019s fast forward ten years.\u00a0 Those original million-dollar investments in Johnson & Johnson and Wal-Mart would be paying you $49,244 and $34,144, respectively.\u00a0 Wal-Mart\u2019s total cash payout is still a little lower than the payout from the Treasury note, though it rose by more than a factor of 5\u2014and will likely keep rising at a blistering pace for the foreseeable future.\u00a0\u00a0 And again, this says nothing about capital gains\u2014or about the reinvestment of dividends, which would have boosted the number of shares you owned and thus your ultimate payout.<\/p>\n\n\n\n\n\n\n\n
<\/td>\nIncome on $1 million invested in 2003<\/td>\nIncome in 2013 on original 2003 investment<\/td>\n<\/tr>\n
10-Year Treasury<\/td>\n\u00a0$40,000<\/td>\n\u00a0$40,000<\/td>\n<\/tr>\n
Realty Income<\/td>\n\u00a0$34,534<\/td>\n\u00a0$64,345<\/td>\n<\/tr>\n
Johnson & Johnson<\/td>\n\u00a0$15,296<\/td>\n\u00a0$49,244<\/td>\n<\/tr>\n
Wal-Mart<\/td>\n\u00a0$6,538<\/td>\n\u00a0$34,144<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

What lessons can we learn from this?<\/p>\n

Dividend growth matters far more than current yield<\/b>.\u00a0 When building an income portfolio, accept a lower payout today in the interest of generating a far bigger payout tomorrow.\u00a0 As in so many other areas of investing, delayed gratification has its rewards.<\/p>\n

I\u2019ll leave you with one final point on inflation and taxes.\u00a0 The first is obvious.\u00a0 Prices rise over time, and the only way you can avoid getting progressively poorer in retirement is to have an income stream that at least keeps pace with inflation.<\/p>\n

Finally, depending on how you are invested (IRA vs. taxable account), taxes will play a role in your \u201ctake home\u201d income.\u00a0 If investing in a taxable account, you will pay 15-20% on your dividend income, depending on your income bracket and whether the dividends are \u201cqualified.\u201d\u00a0 Bond interest is taxed as ordinary income, meaning you could be paying a substantially higher rate, depending on your tax bracket.<\/p>\n

Disclosures: Sizemore Capital is long O, WMT, and JNJ.<\/p>\n

SUBSCRIBE\u00a0<\/b><\/a>to\u00a0Sizemore Insights<\/em>\u00a0via e-mail today.<\/p>\n

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