Dividend Yield Or Dividend Growth, Which Is The Most Important?

This is a guest contribution by Robert Kovacs.

Fellow dividend growth investors (DGIers), how many times have you read online that you shouldn’t chase dividend yield but should instead focus on growth?

If you’re like me and my son Sam, you’ve seen this way too many times. The idea has become a widely accepted mantra in the dividend investing world, but there’s a catch: nobody has ever backed up the claim… until now.

In this article, I will be running several simulations to settle the debate once and for all. You will be able to confidently assess which dividend stocks fit your profile based on the info in this article.

The short answer to the question in the title? It depends. You want the long answer? Keep reading.

Before diving into the results of my research, I would like to open this article with one of my son’s favorite quotes.

“It’s not what you don’t know that gets you killed, it’s what you know for sure that just ain’t so”.
– Quote attribution disputed

This quote is extremely powerful when applying it as an investor. Badly founded beliefs are one of the first sources of costly mistakes when investing.

Common misconceptions about financial markets influence thousands of investors around the world every day. Such as:

“Markets are efficient thus you cannot beat it”

“You need to own bonds as well as stocks”

“You need dozens of stocks do be diversified”

And finally, the one which interests us today:

“Dividend growth is more important than dividend yield”

I am not sure of the exact reason this mantra was adopted unanimously by the community but it certainly happened somewhat like this.

You learn about DGI.

You get excited about companies paying out 10-12% dividends.

You buy them thinking you get the deal of the decade, it is undeniable, you are the new George Soros.

These stocks slash their dividend, and you’re left with an asset whose price has decreased dramatically.

You sober up and buy Johnson and Johnson (JNJ) at a 2.5% yield. After all, if the dividend grows at a 7% rate for the next 20 years, your yield on cost (YOC) will be about 10% in 20 years.

You now experience less ups and downs, you are reassured by the rest of the community who tells you what you are doing is great, and you will have conservative, reasonable returns throughout the rest of your life.

“Once you start asking questions, innocence is gone.”
– Mary Astor

And it’s a reasonable choice. Some might even say you have learned your lesson and this is the sensible thing to do. But is it the best thing to do? What if you want to optimize your earning potential?

It always seemed logical to me that two investments – one with a high dividend yield and low dividend growth, and one with the opposite attributes – could be just as equally attractive investments.

It also seemed to make sense that over time that low dividend yield and high growth would eventually beat high yield and low growth investments.