Better Buy: Big Dividends or Fast-Growing Dividends?

A couple of my fellow Fools seem to have a bit of a disagreement. In his article "The Most Outstanding Dividend Portfolio I Know," Jeremy Phillips said he believes "dividend growth, much more than current yield, is critical to a successful dividend portfolio."

Meanwhile, in his article "The Outstanding Dividend Stock I'm Buying Now," Jim Royal countered, "I think a high current and sustainable yield is every bit as important as growth."

So who's right? Should we be focusing more on a company's ability to grow the dividend or give preference to higher current yields?

To the numbers! (Jeremy's turn)
Jeremy was looking for stocks with above-average dividend growth, so I pulled up all of the stocks with a market cap above $500 million as of a decade ago that also had positive dividend growth over the three years ending in 2000. I then found the average dividend growth of the group (11.9%) and cut down the list to just the companies with dividend growth above that average.

The average dividend-adjusted return for that group was 88.4% -- far better than the 4.4% loss the S&P 500 delivered over the same period.

I then ran through the same exercise for the past five years. This time the average dividend growth rate was 20.8% and the average dividend-adjusted return for the stocks that had above-average dividend growth was 26.7%. Once again, investors focusing on dividend growth did well, easily besting the S&P's 1.7% return over the same period.

To the numbers again! (Jim's turn)
Jim wants higher current yields, but he also wants sustainable yields. Since the specific stock in question for Jim was National Grid (NYSE: NGG  ) , with a whopping 7% yield, I took it to mean that he's looking for more than just above-average yields. As for the sustainable part, I figured that meant Jim would steer away from any stock with a payout ratio above 100%.

Once again, I focused on all of the companies with a $500 million market cap or higher 10 years ago. I excluded all companies with a payout ratio above 100%, then split the group into deciles and grabbed the top decile, which had a minimum 4.9% yield. The average dividend-adjusted return for the group that remained was a whopping 187.3%, not only better than the market's small loss, but also topping the dividend growers' 88% return.

As above, I ran the whole exercise again for the period over the past five years. This time the low-end dividend was a bit lower at 4.3%, but the average dividend-adjusted return of 26.9% once again beat the results from the dividend growers -- though by a razor-thin margin.

Grab those high yields!
The results don't come as a big shock to me, as I found similar results when looking at high-yield stocks and dividend growers last year. Granted, these results aren't exactly statistically robust, so don't take this as an immutable law of investing.

Of course, if you want to bag some of the stock market's high-yield magic, you can hop onboard National Grid with Jim -- it has a 7% yield and a 51% payout ratio -- or you could take a closer look at one of the following stocks. Each has a market cap above $500 million, is currently in the top decile in terms of dividend yield, and has a payout ratio below 100%.

Company

Dividend Yield

Payout Ratio

Getty Realty (NYSE: GTY  ) 6.9% 98%
Altria Group (NYSE: MO  ) 6.3% 77%
AT&T (NYSE: T  ) 6.1% 45%
ONEOK Partners (NYSE: OKS  ) 5.6% 83%
OneBeacon Insurance (NYSE: OB  ) 6.0% 48%

Source: Capital IQ, a Standard & Poor's company.

Will all of these stocks outperform in the years ahead? Maybe not. However, if history is any guide, we're pulling from a good bucket when we focus on high-yielding stocks with sustainable payout ratios.

In considering which high-yielding stocks I might want to buy, I always examine the underlying business. What I'm looking for is first whether it's a business I can understand; if it's too complex, I skip it. Next, I'm looking for whether it's a business whose products or services will be in demand five and 10 years down the road. For me, all of the companies above fit the bill.

However, the same process has kept me away from some of the highest-yielding stocks -- the mortgage REITs like Hatteras Financial (NYSE: HTS  ) , which yields more than 14%. Hatteras, like many of the other mortgage REITs, has only been around for a few years, so there's no history of how the company is able to operate in environments other than the current ultralow-rate one, which is not only ideal for the mortgage REITs but also unsustainable for the long term.

Go big or go home?
As I noted above, the numbers I've dug up are hardly conclusive in the dividend debate. What I think is important to bear in mind is that both groups – high yielders and high dividend growers -- handily beat the S&P over the past five and 10 years. I don't believe that's a coincidence. So while the debate about big dividends and fast-growing dividends may continue to rage, just make sure you're getting dividends.

If you're a dividend investor you're certainly in good company. After all, Warren Buffett is a dividend investor.

National Grid and ONEOK Partners are Motley Fool Income Investor recommendations. The Fool owns shares of Altria Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer owns shares of AT&T, but does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


Read/Post Comments (9) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 25, 2011, at 4:44 PM, TominTexas wrote:

    "National Grid (NYSE: NGG), with a whopping 7% yield"

    Dividend = $2.05

    1/25 closing price = $44.04

    Yield = 4.65% [not whopping 7%]

  • Report this Comment On January 25, 2011, at 6:55 PM, DDHv wrote:

    My primary watch list is on a spreadsheet to make calculating and sorting easily. One calculated figure is: current dividend yield, multiplied by 5 year increase ratio.

    When it is time to modify my active watch list, companies on the primary list are sorted, then another sort is done on companies that were not the worst ones, using different key or calculated statistic, until the list has been trimmed to a small amount of companies that haven't turned up worst in any statistic. These are then checked in detail.

    The active watch list checks prices for bargains. It figures a buy at and sell at limit price for each company, based on the input figures and an adjustment for each. The companies are sorted by %lo for the week. For buy, resulting prices are along a set of from current price to the two year past low. For sell, prices are %s between two year high and current. If there is a sudden general price drop, limit prices might buy a few best bargains. A sudden price rise produces best bargain sales. After a buy, the buy adjustment is changed to lower buy limit prices. After a sell, the sell adjustment is changed to lift sell prices. At the weekend, both are moved toward the current price. Eventually some transaction occurs, in the meantime volatility is used to advantage.

  • Report this Comment On January 25, 2011, at 10:06 PM, TMFKopp wrote:

    @TominTexas

    Can I assume you're getting your info from Yahoo!Finance?

    When it comes to foreign issuers in particular, you need to be very careful about the dividends. Yahoo in particular does a bad job with this because it tends to just double the most recent dividend payment. For NGG this will show a dividend that's lower than reality in the interim period and a dividend that's higher than reality in the final dividend period. To get an accurate view of the company's dividend you need to go to the company's investor page.

    Matt

  • Report this Comment On January 26, 2011, at 12:12 PM, TominTexas wrote:

    @Mat

    Yup, Yahoo numbers.

    Thanks for the reply and info. I've noticed this before and wondered about the conflict.

  • Report this Comment On January 26, 2011, at 7:29 PM, TMFKopp wrote:

    @TominTexas

    Sure thing!

    I wish there was an easier way to handle foreign dividends, but there just doesn't seem to be a source other than the companies' own IR pages that consistently get it right. It also makes screening for foreign dividend payers a little extra challenging.

    Matt

  • Report this Comment On January 26, 2011, at 7:32 PM, TMFKopp wrote:

    @truthisntstupid

    I have to admit, this was not the result I was expecting / hoping for when I ran through this exercise. My hope was to be able to say that companies that pay a moderate dividend and consistently grow it show the best results. But, at least according to these numbers, that doesn't seem to be the case.

    Some of it probably has to do with the fact that a dividend yield is a sort of valuation metric -- that is, a higher dividend yield typically corresponds to a lower valuation. So the performance of high-dividend stocks would simply hold with the more general idea that stocks that carry low valuations and have been tossed aside by the rest of the market end up performing better.

    Matt

  • Report this Comment On January 26, 2011, at 7:33 PM, TMFKopp wrote:

    @truthisntstupid

    You brought this stock to my attention. I wish now I had jumped at it sooner, but it still looks like a good deal today:

    http://www.fool.com/investing/value/2011/01/26/how-much-is-m...

    Matt

  • Report this Comment On January 26, 2011, at 8:29 PM, XMFShirKi wrote:

    Hey Matt,

    Great article. My friend (who I recently introduced to Fool.com) sent it to me. I'm looking for dividend players right now, myself, so you've given me some great things to look for.

    However, is it possible that the calculation is a bit tilted towards the second category, since you took the above average stocks in the first but only the top decile in the second?

    Take care,

    -Shiri

  • Report this Comment On January 27, 2011, at 12:41 AM, TMFKopp wrote:

    @TMFShirKi

    "However, is it possible that the calculation is a bit tilted towards the second category, since you took the above average stocks in the first but only the top decile in the second?"

    Well, it really depends, right? If big dividends are good and bigger dividends are better then going with the decile instead of "above average" would boost the results. And if fast-growing dividends are good and faster-growing dividends are better, then I'm hurting that group by going with the "above average."

    But if the biggest dividends aren't better than just big dividends, then going with the top decile might not be a good thing. And the same for the growing dividends.

    But before a blow too much hot air, I'll do something useful....

    I pulled my spreadsheets back out and reran the numbers for the dividend growers, but this time using just the top decile of the dividend growers rather than all of the "above average" growers. This time the average return was 109.6% over the past decade and 27% over the past five years.

    So better in both cases. The decade tally still falls significantly short of the big-payers though and the 5-year result is still basically even with the big-payers.

    The reason that I didn't do this initially was that what Jeremy seemed to be looking for were moderate-to-high growers. When using the top decile you're just getting the break-neck growers, which includes a lot of companies that have been paying small dividends for a very short period of time (and therefore don't have to raise the div by very much to get significant growth).

    In any case, even when we even the playing field, it looks like the results are still tilted towards the higher yields.

    Hope this helps!

    Matt

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