Is a High-Yielding Dividend Stock Better Than a Growing One?
Dividend investors looking to maximize their returns should always consider which type of stock works best for them. And ultimately, a big consideration is how long you plan to hold on to an investment for. Dividend stocks yielding 8% per year might be very attractive over the short term, but will the stock still be paying such a high percentage 10, 15 years down the road?
Meanwhile, stocks that have lower dividends but that increase every year might be better long-term buys. The big question is at which point does a growing dividend earn more for an investor than a dividend that doesn’t increase, but that offers a higher payout today?
Let’s take a closer look at this using Toronto-Dominion Bank (TSX:TD)(NYSE:TD) as an example. Currently, the stock pays investors a dividend of 3.8%. However, over the past five years it has increased dividend payments by an average of 9.5%. That’s a pretty big increase. Whether you’re looking at a high-yielding dividend or one that’s high growing, there’s always a risk that those payouts won’t continue over the long term. So let’s ignore that risk for now and just make an assumption that the payouts are entirely safe and these patterns will continue without issue.
I’m going to use a sample scenario where we invest $10,000 into TD stock as well as a dividend stock that pays 8%. Below is the effective yields would look like over the next 20 years:
As you can see, it’ll take about nine years for you to be making the same yield with TD’s stock that you would have been making from the higher-yielding stock. However, let’s take a look at how long it would take for your actual dividend income to be higher under the growing dividend:
Even though year nine is when the yields meet, TD’s stock won’t earn greater lifetime returns until year 16. That’s a long time for the stock to play catch up. Let’s adjust the model and say the high-yielding stock is only 7%:
Now it would be year 14 when TD would have more in dividend income, two years earlier than with an 8% yield. However, one other problem I’d want to adjust for is that 9.5% is a very high rate of increase, and that seems like a very optimistic rate. Many dividend stocks don’t hike their payouts by that rate. Instead, I’d say 5% is more realistic. Here’s how the mode looks if payouts increase by just 5% and the high-yielding stock is 7%:
In this model, TD doesn’t outperform the higher-yielding stock even after 20 years. The difference between growing at 5% vs 9.5% has made a significant impact on the model and it’s important for investors to not neglect this fact. Even though TD’s dividend rate of 3.8% may not seem that far away from a 7% yield, it takes a lot time for that gap to shrink.
And so while a growing dividend stock is very important to investors, unless you’re playing to hold the stock for at least a couple of decades, it’s not likely going to make up for a high-yielding stock. The takeaway for investors here is that if you’ve got the opportunity to lock in a high yield for a good stock, it might prove to be a better option than investing in a lower-yielding dividend that’s growing. While the growing dividend is promising, it’ll take a long time for investors to see a big advantage in their portfolios.