Author Topic: Dividend growth - how does that work?  (Read 6335 times)

DaKini

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Dividend growth - how does that work?
« on: March 25, 2014, 06:33:24 AM »
Hello,
i wonder if i got dividend growth right and hope for some support regarding this question.

Companies pay dividends that is my share of the profits. Eventually the dividens will hopefully be risen due to better profits and other reasons (im aware that they can also be cut but in terms of my question this does not matter).

Suppose now the following:
2014: I buy 100 shares of company A for a share price of $1 for a total of $100. They currently propose that they will pay $0.02 per share which gives a dividend yield of 2%. They keep their promise and pay me my share of $2, so my investment of $100 yielded 2%.
2015: The dividend was raised to $0.03 per share.

Is it now true, (given share price remains the same $1) that my initial investment of $100 will now have a yield of 3%?
And regarding my $100 investment, the yield will rise with each dividend rise, so i may end up with a yield of say 10% somewhere in 2030, as of "the $100 invested in 2014 yield $10 now every year" when the divident has risen to $0.10?
I ask, because the share price is volatile and "masks" my real yield this way, because if the yield rises (dividend rise or price decline or both) demand for the stock will rise, driving prices up; which in turn will lower the yield - but that does only affect new investments at that time and not my already established holdings... isn't it?
That would also mean, that once i consume my dividends (and not reinvest) my overall portfolio yield would also slowly rise continously, is that true?

I cant imagine that money printing machine being real. I must have a flaw in my thoughts. But where is it?
« Last Edit: March 25, 2014, 06:46:24 AM by DaKini »

Thespoof

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Re: Dividend growth - how does that work?
« Reply #1 on: March 25, 2014, 07:26:06 AM »
I invest in dividend stocks in my TFSA as I hope to gain a stream of tax free income. I do look at yield to a point, but I'm more interested in the pure cash flow as it creeps ever higher and is able to start covering my living expenses. If my bills are being covered I could care less if I'm getting a 3% or a 5% yield.

seeking_north

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Re: Dividend growth - how does that work?
« Reply #2 on: March 25, 2014, 07:57:57 AM »
DaKini: A bit difficult to follow, but I will try.

A prosperous company, will pay out a dividend, or a share of the earnings to their shareholders. When that company trives and earns more money each year, they will pay out more money.

Say, company A earns $1 per share, or EPS. They decide they will pay some of it out to their shareholders, and decideds 50% is enough. Because they need some to reinvest themselves. So, they keep 50% and we recive 50% or $0,5.

Next year, the company has done well, and the years ahead looks ok, so they decide to keep paying 50% of their earnings, which now has increased with 10%. That gives a EPS, of $1,1. So, we recive 50% and they keeps 50% for reinvestment. So out take this year is $0,55 or a 10% increase in the dividend. This has beaten inflation ( somwhere around 1-5% depending on the country ), and increased our earnings alongside the company.

Since this started decades ago, and people needed to proctect their savings, companies tried to shield investors and retierees by increasing their dividend to atleast beat inflation.


In year 3, a bad year, when their earnings are down, say, only making $0,7, they will still increase their dividend, to shield investors from inflation but, at a cost of not keeping the same amount as shareholders. So we recive $0,55 x 5%, which is $0,577. But that only leaves $0,12 for the company. They are now paying out 82% of their Free cash flow, $0,577 / 0,7EPS. This is not viable in the long run, but if it where only a bad year, the EPS will increase again, giving them a chance to pay out more.

This insures that the company always, always tries to be as profitable as possible, so that they will never need to cut their dividend. Which is seen as a weakness, and scares away those seeking a inflation beating investment.


In Europe this is somwhat different. There, the investerors are rewarded when a company has a good year, and when there is a bad year, the investors recives less or nothing. Very few german companies pays out a increasing dividend each year.


But yes. If I invest $100 in a company that yields a 2,5% dividend, and earns more each year, they will try to increase the dividend. So with compounding interest ( the worlds 8th miracle, according to Einstein ) this increased dividend will in 10-15-20 years give more and more intrest on the initial investment. A 2,5% dividend, increasing with a flat 10% each year, will increase to 6,5% after 10 years.

A $100.000 investment at year 0, gives $2500
After 10 years: $6500.
After 15 years: $10400
After 20 years, $16820

You still have your $100.000 invested, recive $16000 - tax,  each year, and can do whatever you want with it. Reinvested during your working years, will increase this amount substantively! Also, at the same time, the initial stock price will have risen, as well.




Piuuuh.. did I answer your question? :)
« Last Edit: March 25, 2014, 08:05:43 AM by seeking_north »

pom

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Re: Dividend growth - how does that work?
« Reply #3 on: March 25, 2014, 08:18:47 AM »
It is true that dividends are pretty close to a money printing machine, that is what I love about it.

So years you will print more, others you will print less but as I see it, I am paid to do nothing.

Sure it is risky but is it really?? If you hold the market index and you are in a situation where you will never need to sell, how risky is it?

Just one point, be weary of unreasonable dividends, it is usually not a good sign.

DaKini

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Re: Dividend growth - how does that work?
« Reply #4 on: March 25, 2014, 08:29:02 AM »
Quote
Piuuuh.. did I answer your question? :)
Yeah, thanks for affirming im not nuts and for your lenghty insights.
This is awesome and indeed a miracle. A real cash cow...

For my question it was not so important if or that companies pay rising dividends.
The fact i was not sure about was that the publicy shown dividend yield of a stock is not fixed in eternity and only matters when buyhing fresh shares AND that the real dividend yield is based on my initial share price vs current dividend in money units.
That is, stocks with dividend payments are instruments with a flexible yield. Which is cool if the dividend is risen.

We will profit from proserous companies twofolds:
- first, dividend is risen because for example the company was prosperous.
- this drives up dividend yield
- this in turn attracts fresh money which will rise stock price
- after the stock price has risen, dividend yield would have been lower again, but my real yield on my investment has risen permanently (or better, as long as the dividend will not be cut)


Besides that, i hold ETFs mainly to easily diversify broadly and worldwide which should greatly reduce non-systematic risks.
I hope, one time the main income will be from dividends, but that is a long way to travel.

But i think, knowing that my initial investments from some years (eventually decades) ago have a greatly higher yield than the ones i am currently buying should help mitigate the emotional wish to sell in bad times.

Thank you all showing that i understood this stuff a little more.

skyrefuge

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Re: Dividend growth - how does that work?
« Reply #5 on: March 25, 2014, 08:35:46 AM »
I cant imagine that money printing machine being real. I must have a flaw in my thoughts. But where is it?

Yes, your flaw is your assumption that Company A will steadily increase its dividend at the rate you project. It might, or it might not. Essentially you're saying "if I assume that Company A will provide excellent investment returns, then when I do the math, it looks like Company A provides excellent investment returns. Is this for real?!?"

Note that of the 26 companies in the original Dividend Aristocrats index (those who had increased their dividends for 25 years up to 1989), only 7 remained in the index 20 years later. Past performance is no guarantee of future results.

But yes, at least historically, the stock market has been a pretty awesome tool for generating wealth. But the magic you're seeing in your numbers really comes from investing early and waiting a long time, and doesn't have any specific relation to dividends.

Instead of buying Company A, you could buy $100k of Company B (using seeking_north's numbers), which pays no dividends. Assuming its share price increases at 10% per year, after 20 years your holding will be worth a whopping $672k, and you'll be able to pay yourself the same $16820/year "dividend" by selling a mere 2.5% of the shares you hold. Since the share price continues to rise at 10% per year and you're taking only 2.5%, your principal will continue to grow like a massive volcano even as it's spouting lava into the air.

So you can see that there's really nothing uniquely powerful about dividends themselves. The power comes from the businesses that make up the stock market and the assumptions you make about them.
« Last Edit: March 25, 2014, 08:37:35 AM by skyrefuge »

seeking_north

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Re: Dividend growth - how does that work?
« Reply #6 on: March 25, 2014, 09:05:55 AM »
Yes, but the dividends makes sure that the company is not doing anything stupid with all that money.

When they have to consider paying out to investors, or using it to buy unscroupulously other companies, their own stocks at the height of the stockmarket, those that pay out a sum to their owners does better over longer periods of time. They are making sure they are turning over every dollar.

Now there are 104 Dividend Aristocrats, who has payed out more then 25 years in a row. Many of them are companies that effectivly dominates their markets, both domesticaly and international.

There is no rule that says all those will continue, most certainly many will fall by the wayside... but then you sell them!


And, looking back only 2 out of 104 Dividend Aristocrats kept on paying and increasing their dividend during 2008/9.
You better hope you dont need to cash out some of your portfolio to raise money to live on during those years.
« Last Edit: March 25, 2014, 09:09:01 AM by seeking_north »

gobius

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Re: Dividend growth - how does that work?
« Reply #7 on: March 25, 2014, 09:09:38 AM »
To answer your original question, you are correct.  If you buy something for $1 per share and it goes up to $2 per share, you don't have to pay another $1 per share just because you already own it.  Now, if you buy want to buy a new share, it would cost $2 per share.  If it is paying $0.02/share dividends at first and then rises to $0.10/share in 20 years, you will be getting 10% dividends based on your original purchase (cost basis).

It's like if you buy a house for $100K and rent it out for $1,000 per month, or 1% of the home value.  If you raise rent over the next 10 years to $1,500/month, you are now collecting 1.5% of your original purchase price.  Your house may now be worth $150K, so if you wanted to buy one just like it you would probably have to pay $150K, but the original purchase price isn't affected.

Of course, taxes are also involved if you make enough money.  That's why some people don't put high-dividend-paying stocks in their taxable accounts but rather put growth stocks as they are counting on the share price to go up.  They only pay taxes when they sell the shares rather than every year when they collect dividends.  If you make little enough money, though, you don't have to worry about taxes on qualified dividends.

So,

Quote
Suppose now the following:
2014: I buy 100 shares of company A for a share price of $1 for a total of $100. They currently propose that they will pay $0.02 per share which gives a dividend yield of 2%. They keep their promise and pay me my share of $2, so my investment of $100 yielded 2%.
2015: The dividend was raised to $0.03 per share.

Is it now true, (given share price remains the same $1) that my initial investment of $100 will now have a yield of 3%?

Is correct.
« Last Edit: March 25, 2014, 09:12:52 AM by gobius »

skyrefuge

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Re: Dividend growth - how does that work?
« Reply #8 on: March 25, 2014, 09:11:38 AM »
For my question it was not so important if or that companies pay rising dividends.
The fact i was not sure about was that the publicy shown dividend yield of a stock is not fixed in eternity and only matters when buyhing fresh shares AND that the real dividend yield is based on my initial share price vs current dividend in money units.

"Yield on cost" (YOC) is the term frequently used by dividend-focused investors that is equivalent to your "real dividend yield". Whatever the name, is that number really useful to you for anything? I think what you actually care about is the amount of money your investments can generate, in raw dollars (euros), to fund your current spending needs.  If you take that raw dollar amount and then do some math on it taking numbers from ancient history, sure, you can generate some other numbers, like YOC, but what is the value in that mathematically generated number? If my $100k investment generates $16820 of income per year, I can multiply that by the acceleration due to Earth's gravity divided by the number of world wars in the previous century and come up with a Yield on Gravity Wars of $16820 * 9.8 / 2 = 79772. Whoa, my YOGW is huge!

Again, let's take take seeking_north's numbers. Your initial $100k investment (10000 shares at $10) in a stock generating $2500 per year (a 2.5% yield) after 20 years of dividend growth is generating $16820 per year. You now have a 16.8% YOC. Assume the share price has also increased proportionally to $67, so that the current yield is the same 2.5% ($16820 / (10000 * $67)) as when you originally purchased your shares. Ah, those poor suckers buying today, they're only getting 2.5%, while you're getting 16.8%!

But wait. Say you sell all of your shares at that $67 price. Then a week later, you change your mind. Luckily the share price hasn't moved in that week, so you can repurchase at the same price. Unfortunately you lost your awesome 16.8% YOC, and now it's only the 2.5% that new buyers get. But wait, you own 10000 shares @ $67, and 2.5% of that is $16820!

If your YOC can change from 16.8% to 2.5%, yet have no effect on your income or anything else, hopefully that shows how YOC is an artificial number that doesn't tell you anything very useful.

warfreak2

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Re: Dividend growth - how does that work?
« Reply #9 on: March 25, 2014, 09:17:07 AM »
To answer your original question, you are correct.  If you buy something for $1 per share and it goes up to $2 per share, you don't have to pay another $1 per share just because you already own it.  Now, if you buy want to buy a new share, it would cost $2 per share.  If it is paying $0.02/share dividends at first and then rises to $0.10/share in 20 years, you will be getting 10% dividends based on your original purchase (cost basis).
On the other hand, if shares are $2 and the dividend is $0.10, it's also correct to say that the yield is 5%, even if you didn't buy any shares for $2. This would be a direct comparator to other investments that you might sell your shares in order to buy; if you think you could reliably get more than a 5% yield from something else, then that's actually better than your "10% yield". So, either way of thinking about it may be more appropriate, depending on context.

wesley

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Re: Dividend growth - how does that work?
« Reply #10 on: March 25, 2014, 09:20:02 AM »

But wait. Say you sell all of your shares at that $67 price. Then a week later, you change your mind. Luckily the share price hasn't moved in that week, so you can repurchase at the same price. Unfortunately you lost your awesome 16.8% YOC, and now it's only the 2.5% that new buyers get. But wait, you own 10000 shares @ $67, and 2.5% of that is $16820!

If your YOC can change from 16.8% to 2.5%, yet have no effect on your income or anything else, hopefully that shows how YOC is an artificial number that doesn't tell you anything very useful.

this is brilliant, seriously that one sentence at the end summed it up perfectly, its still a certain yield based on todays dollars, or your portfolio value in the market, I hadnt thought about it like this before - great way to explain it.

gobius

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Re: Dividend growth - how does that work?
« Reply #11 on: March 25, 2014, 09:22:42 AM »
To answer your original question, you are correct.  If you buy something for $1 per share and it goes up to $2 per share, you don't have to pay another $1 per share just because you already own it.  Now, if you buy want to buy a new share, it would cost $2 per share.  If it is paying $0.02/share dividends at first and then rises to $0.10/share in 20 years, you will be getting 10% dividends based on your original purchase (cost basis).
On the other hand, if shares are $2 and the dividend is $0.10, it's also correct to say that the yield is 5%, even if you didn't buy any shares for $2. This would be a direct comparator to other investments that you might sell your shares in order to buy; if you think you could reliably get more than a 5% yield from something else, then that's actually better than your "10% yield". So, either way of thinking about it may be more appropriate, depending on context.

Good point.  You wouldn't want to pass up a 7% yield investment (all else equal) because you're getting 10% on your original cost, but only 5% on your current value.  You could sell your asset and buy the 7% yielding one, making a 2% higher yield.  I suppose that's what skyrefuge is getting at.

seeking_north

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Re: Dividend growth - how does that work?
« Reply #12 on: March 25, 2014, 09:39:23 AM »
Having a asset yielding you 16% after 20 years. ( In my example, which might or might not be true to a "real" stock )

Its protected by inflation.

I dont have to sell it to reap the revards.

It`s increasing each year, you can reinvest into the company every quarter increasing your income even more.

Its cheaper then a indexfund.

I dont care about the stock price when I need the money.


DrTesla

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Re: Dividend growth - how does that work?
« Reply #13 on: March 25, 2014, 10:50:43 AM »
Big company CEO's love it with their 25,000,000 shares added annually on top of their base pay, matching bonus checks, and many perks of the executive business side. Though all the responsibility for the lives of the people and what orders to give them to sustain growth.

wtjbatman

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Re: Dividend growth - how does that work?
« Reply #14 on: March 25, 2014, 06:46:27 PM »
It works pretty damn well, that's how that works :)

The value of a strong and growing dividend is actually more than just the dividend itself, it is an indicator of the health of a business. There are exceptions of course, particularly companies with unsustainably high yields, but those are normal red flags you watch for. If a company has a consistently growing dividend that they have no trouble paying out, that company is likely a healthy business.

hodedofome

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Re: Dividend growth - how does that work?
« Reply #15 on: March 28, 2014, 02:44:34 PM »
All things being equal, if 2 stocks have the same yield, you want to buy the stock with the lowest Payout Ratio. This is the ratio of dividends vs earnings. If company A is paying 50% of their earnings out as dividends each year, but company B is paying only 30% of their earnings out as dividends, then company B is a better buy (all else equal) because they have more room to increase their earnings in the future. You'll notice that a lot of stocks out there have increased their dividends substantially the past decade, but have done so without increasing their earnings. They are simply paying out more dividends at the expense of being able to invest in their business.

You want to make sure that you are buying a dividend stock at a fair or cheap valuation. High dividend stocks are the most overvalued of all the stocks in the US market. Everyone is chasing yield in this no interest rate environment. It's quite possible you are a little late to the party and may be stuck cleaning up the mess.

You also want to look at stock buybacks and debt paydown. This is called 'shareholder yield' and is a much more holistic way of looking at how a company uses it's cash. A lot of companies are choosing to repurchase shares instead of pay dividends and just focusing on dividends means you could miss out on some good stocks out there.

One of, if not the most, important things to do in a dividend growth strategy is to project the earnings into the future. How sustainable is the current dividend payment? How much room does the company have to grow their dividend without hurting their reinvestment? Can they be easily competed with and their earnings disappears overnight? (tech stocks are very susceptible of this). Taking the fact that a company raised dividends by 7% a year for the past 10 years does not mean you can expect that in the future. It has to have a wide moat to keep competitors from disrupting their business. 

DaKini

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Re: Dividend growth - how does that work?
« Reply #16 on: March 29, 2014, 02:12:50 AM »
Thank you!
Is this also a concern with index fonds and if yes how?

RabStache

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Re: Dividend growth - how does that work?
« Reply #17 on: March 31, 2014, 08:07:26 AM »
I had a similar question because recently I saw an article on Dividend Investing vs Index Investing.  I assumed Index's still paid dividends?  I'm not sure how compounding would work without dividend reinvesting but I'm very new to this so I could just be confused!

kyleaaa

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Re: Dividend growth - how does that work?
« Reply #18 on: March 31, 2014, 08:23:20 AM »
An investment's yield-on-purchase-price 10 years down the road is hardly relevant. What matters is how you can most effectively deploy your capital NOW.

Quote
I ask, because the share price is volatile and "masks" my real yield this way, because if the yield rises (dividend rise or price decline or both) demand for the stock will rise, driving prices up; which in turn will lower the yield - but that does only affect new investments at that time and not my already established holdings... isn't it?

Incorrect. Share price doesn't mask real yield. Your real yield is based on the current value, not whatever you paid for it. What you paid for it is irrelevant. Yield on cost is not a useful metric.

Quote
That would also mean, that once i consume my dividends (and not reinvest) my overall portfolio yield would also slowly rise continously, is that true?

Incorrect. Your yield will go up or down based on current market conditions, not whether or not you reinvest dividends.
« Last Edit: March 31, 2014, 08:28:17 AM by kyleaaa »

seattlecyclone

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Re: Dividend growth - how does that work?
« Reply #19 on: March 31, 2014, 11:57:46 AM »
I had a similar question because recently I saw an article on Dividend Investing vs Index Investing.  I assumed Index's still paid dividends?  I'm not sure how compounding would work without dividend reinvesting but I'm very new to this so I could just be confused!

Index funds generally pay a dividend proportional to the dividends paid by the stocks in the fund. So if the market-cap-weighted average dividend in the S&P 500 is 2%, you should expect to get a 2% dividend from your S&P 500 index fund.

Compounding can work just fine without dividend payments. Take a look at Berkshire Hathaway. They've never paid a dividend, but the stock has doubled in value several times since Warren Buffet took over. The dividend payments aren't what matters, it's the overall growth in your investment over time.

hodedofome

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Re: Dividend growth - how does that work?
« Reply #20 on: April 01, 2014, 11:42:17 AM »
I had a similar question because recently I saw an article on Dividend Investing vs Index Investing.  I assumed Index's still paid dividends?  I'm not sure how compounding would work without dividend reinvesting but I'm very new to this so I could just be confused!

Index funds generally pay a dividend proportional to the dividends paid by the stocks in the fund. So if the market-cap-weighted average dividend in the S&P 500 is 2%, you should expect to get a 2% dividend from your S&P 500 index fund.

Compounding can work just fine without dividend payments. Take a look at Berkshire Hathaway. They've never paid a dividend, but the stock has doubled in value several times since Warren Buffet took over. The dividend payments aren't what matters, it's the overall growth in your investment over time.

True, but there are not many CEOs that can reinvest their cash like Buffet. Most CEOs are ill-equipped in capital allocation. It's probably a good idea that a lot of companies pay dividends, otherwise they'd be tempted to make stupid acquisitions that would destroy shareholder value in the end.