Dividend Growth Investing Vs. High-Yield Investing (2024)

As a dividend growth investor, I focus on the income stream. The relative simplicity of choosing established companies with long dividend histories is very appealing. Not worrying about the day-to-day market fluctuations or what the market will do next year is very freeing. The term "sleep well at night" is often overused anymore but knowing my dividend income is growing no matter what allows me to do just that.

Dividend growth investing is different than high dividend investing. DGI focuses on the growth of the dividend. In contrast, a high dividend investor will focus on the size of the distribution. Both styles generally have the same goal, which is to create an income stream.

Now to say both styles have the same goal may be an oversimplification to some. My personal portfolio goal is to grow the dividend stream by 7% organically without reinvesting dividends and 10% with reinvesting. Some DGI investors like to measure success against the S&P 500.

Many high-dividend investors are using the dividends to pay current bills rather than reinvesting. Other high-dividend investors focus on building as much annual income as they can. Whatever the nuances may be, it is safe to say that an investor in either of these styles is working towards a future goal of living off the dividends.

Years ago, I ran a projection on income comparing high-yielding slow-growth stocks with faster-growing companies. I was trying to develop my dividend growth strategy. From an income perspective, it was clear that high-yield companies were superior if income was the goal. I have recreated this model using buckets of stocks from my current holdings.

These buckets are shown below and meant to represent typical positions:

High-Yield Bucket

High-Dividend Growth Bucket

Core DGI Bucket

*Core DGI bucket would typically be composed of high quality DGI stocks like Johnson & Johnson (JNJ), Pepsi (PEP), McDonald's (MCD), Aflac (AFL), and 3M (MMM)

A couple of notes on these buckets:

• The high-yield bucket assumes a 2% dividend growth, which is considerably lower than the 5-year averages of these companies.
• The high growth portfolio assumes a 15% dividend growth. This rate is lower than the combined 5-year growth of these stocks. However, only 23 companies have a 10-year growth rate of over 15% in the entire dividend achiever universe. This number falls to 15 when you take out companies with the most recent increases of less than 7%.
• The core bucket assumes a 3% dividend and 7% dividend growth. Most of these companies currently yield less than 3%. However, for a 30-year model, these numbers look reasonable.

Assumptions in the model:

• Dividend growth matches earnings growth. The stock market is perfectly efficient, and the portfolio's value increases by the growth each year.
• The dividend yield remains constant.
• All dividends are reinvested.
• The portfolio stays fully invested in companies that meet the bucket requirements, no dividend cuts occur, and the growth is consistent year over year.

The core assumptions form the Base Case, but additional variations tested sensitivity. The model evaluated impacts to both portfolio value and income produced.

Base Case Results

The graph below shows the dividends produced by each bucket.

(Source: Wyo Investments)

The graph shows that unless an investor has a very long time frame, the high yield bucket's dividends will always be superior. The shorter the timeframe, the greater the significance. This result is not entirely a surprise. With such a high initial yield, the high-yield bucket has a big head start. The total number of years it takes with fast growth to overtake the high dividend bucket is a bit of a surprise.

Let's take a look at how each bucket did with total portfolio value.

(Source: Wyo Investments)

There is no competition when looking at this case from a portfolio value perspective. The high-growth portfolio blows the others away. With the assumptions, the portfolio growth rate will be the sum of the dividend yield + dividend growth.

Just looking at the Base Case, the question becomes, "why would anyone invest in boring DGI core holding companies?" The answer comes down to risk. Next, I explored some areas of risk within the high-dividend and high growth buckets.

High Yield Bucket Scenarios

I selected a bucket of stocks that I have in my DGI portfolio. A true high yield investor will have a higher average yield on positions. However, this comes with a higher risk of dividend cuts and likely lower dividend growth. It's a reasonable assumption that net of cuts, a high yield portfolio over time will match the yield plus growth I have assumed. Here are some concerns with this bucket in the base case:

1. The 5-year dividend growth average for the selected companies is closer to 5% than the fixed 2%.
2. Over a 30-year horizon, dividend cuts are likely in this bucket. However, the question is, "how fast can the investor react and maintain a consistent dividend yield within the bucket?"

Remodeling using a band of dividend growth from 0% to 5% results in the following dividends and income:

(Source: Wyo Investments)

(Source: Wyo Investments)

In these graphs, the two dashed lines are the 0% growth and 5% growth variation in the high-yield bucket growth.

Obviously, with a 5% dividend growth rate, the income becomes even more superior. But even with no dividend growth, the income remains superior for over 20 years. However, the portfolio value with no growth lags everything else considerably.

As a worst-case scenario for the high-yield bucket, let's assume that the investor can only maintain a 6% average dividend yield with dividend cuts. There is no dividend growth in this scenario.

Here is the resulting graph for income produced:

(Source: Wyo Investments)

Notice that for over 15 years, this portfolio still produces superior income. Although after 20 years, it quickly falls behind. There is no graph shown for the total portfolio value in this scenario, but it is very ugly compared to the base cases.

High Dividend Growth Bucket Scenarios

This bucket as well is comprised of companies that I currently hold. Companies with faster-growing dividends almost always have lower dividend yields. Generally, these companies will be faster growing overall, not just at increasing the dividends. Over 30 years, there are a lot of risks with this bucket.

Only 23 companies in the dividend achiever universe have a ten-year dividend growth rate of over 15%. Thirty years is highly unrealistic, even accounting for swapping into new positions.

The ability to consistently pick stocks with this kind of dividend growth over long periods is akin to fortune-telling. Essentially to pick stocks meeting this criterion is doubling the long-term returns of the market. An accomplishment very few people have done over decades.

Most of the companies that fit this bucket have short (less than 15 years) dividend growth histories, which adds risk.

Remodeling with a band of 10% to 15% dividend growth yields the following:

(Source: Wyo Investments)

(Source: Wyo Investments)

Notice that the reduction in dividend growth has decimated the income. At no point in the 30-year model does the income in this scenario catch either the high-yield or core buckets. This result highlights the primary risk of counting on high dividend growth stocks for future dividends.

Looking at the total portfolio value, we can see that this bucket still outperforms the others. However, it is now about year 20, where we begin to see a significant divergence from the core bucket total value.

Discussion

An exercise like this has many flaws when compared with how things play out over thirty years. Besides the fact I assumed entirely consistent conditions, investors might swap styles, stop reinvesting dividends, or add new capital. However, that doesn't mean there aren't insights to be gained.

Perhaps the biggest takeaway for me is that I am not just interested in the income produced in my portfolio. It is pretty apparent that an income-oriented investor would best off focusing on the highest yielding companies. However, I also wouldn't go so far as to say that the loss of portfolio growth is what turns me away from high-yield investing.

I could probably build a very nice yielding portfolio out of some of out of favor dividend achievers like T, XOM, MO, EPD, PRU, throw in some BDCs, mREITs, preferred stocks, and some CEFs. Maybe someday, when I am ready to pay bills with the dividends, I will do just that. But for now, I would not sleep well with such a portfolio. Of course, I'm not an expert in high yield, so it would require a lot of learning even to attempt such a transition.

People throw around the term "sleep-well-at-night" a lot these days. But the fact is, the core DGI bucket allows me to do just that. Not worrying about my portfolio is important to me at this point. I equate this to less work. Maintaining a high yield portfolio sounds like a lot of work to me. Having to continually evaluate the possibility of dividend cuts and finding replacement income doesn't sound like fun. I'll stick with my boring, lower-yielding, dividend growth stocks that steadily increase the dividends.

The same can be said for trying to hit the high dividend growth jackpot. Most companies with high dividend growth have short payout histories. Of the approximately 160 companies with a 5-year dividend growth rate above 15%, less than a dozen of them have longer than a 15-year payout history. These short histories tell me there is a lot of work and many risks involved with trying to hit this kind of dividend growth.

Of course, companies evolve. Today's high-dividend growth stock may be tomorrow's core holding. Starbucks (SBUX) has a ten-year growth rate of 25%, but this is slowing. With an 11-year growth history, it's a little early to call it a core holding, but it's certainly not a high dividend growth stock anymore. Altria for years was a core holding stock, with a dividend growth rate consistently around 10%. However, its growth rate may slow (as it has recently) and may become a high-yield stock instead.

Bucket Approach to DGI

When looking at each bucket's various risks and opportunities, it is evident that each has some positive qualities. I have concluded that it doesn't have to be an all-or-nothing proposition.

For this reason, I, like many DGI investors, use bucket allocations to evaluate my portfolio. By using bucket allocations, I can capture some of the best from high-yield and high-dividend growth. Of course, my focus is on the core bucket. And, yes, I do have a non-dividend growth bucket.

Using the bucket approach and allocating set amounts into these buckets prevents me from falling into the high-yield trap that catches many DGI investors. Additionally, it helps stops the "fear-of-missing-out" when we reach a point where fundamentals no longer matter. Having a set allocation to non-dividend stocks provides a chance to capture some additional growth in a way that aligns with my comfort level.

My bucket allocations have changed over time, and I expect they will continue to do so in the future.

Currently, my taxable account is dedicated almost entirely to the core bucket. In contrast, my IRA account utilizes an equal amount of the core bucket and a high-dividend growth bucket, with a small amount placed into a non-dividend bucket. I expect my IRA account will move towards a higher allocation in the high-yield bucket when it is time to start living off the dividends.

Thanks for reading! I hope you were able to find some useful takeaways!

Wyo Investments