If you're a dividend investor, a dilemma you may end up reaching is whether you're better off investing in a company that pays a high yield today, or one that has a lower yield but has been increasing its dividend over the years and is likely to continue doing so. Over time, the dividend growth stock may end up being the higher-yielding investment.
But just how long could it take for that to be a reality? Below, I'll compare big-box retailer Costco Wholesale (COST 0.17%), which has been aggressively increasing its payouts, with healthcare giant CVS Health (CVS -1.07%), which hasn't often raised its dividend but offers a notably higher yield today.
How big the gap is today
CVS Health currently pays a dividend yield of 2.7%. It did raise its dividend recently by 10%, but by and large, this isn't a stock known for regular rate hikes. And with the company being in acquisition mode right now, I wouldn't expect that to change. CVS may be inclined to use its available free cash flow to help with its long-term growth rather than spending more of it on an already high yield (the S&P 500 has a yield of only 1.6%).
Costco's yield, however, is a bit more modest by comparison at only 0.7%. Dividend investors may be tempted to skip over that stock if a high yield is important right now. But the quarterly dividend the company pays today ($0.90) has more than tripled from where it was 10 years ago ($0.275). That averages out to a compound annual growth rate of 12.6%.
How your dividend income may change from these stocks over the years
It's important to remember that dividends are discretionary and never guaranteed. And dividend increases are even less of a certainty. For the chart below, I'm assuming that Costco will increase its payouts by 10% per year (which is definitely an optimistic outlook) and CVS will raise its dividend at a more modest rate of 2%. On a $25,000 investment, investors will be collecting close to $500 more in dividends from CVS' stock today. But here's how that could change over time (based on the assumptions noted above):
Data source: Author's calculations.
If you hover over the chart, you'll see the dividend income by year for these two stocks. And under these assumptions, it would take about 18 years of increases for the annual dividend income to be larger from Costco than from CVS. Even at a much higher growth rate, it would take close to two decades to make up for a 2% difference in yield. And that doesn't factor in cumulative dividend income, either. On a cumulative basis, it could take even longer for the dividend income from Costco's to be larger.
Does this mean dividend investors are better off with a higher yield?
A higher yield can be preferable for investors purely seeking a recurring dividend. But for many cases, you'll want to consider other factors as well. For example, Costco occasionally pays a special dividend (in 2020 it declared one that was $10 per share), which can drastically improve your dividend income. Plus, Costco has been the vastly superior growth stock over the years. When including its dividend, the stock's total returns over the past 10 years are 506% versus 122% for CVS.
Dividend growth stocks can help increase your recurring income over the years, but it's important for investors to have realistic expectations as to how long it may take for dividend income to become higher than that of a higher-yielding stock. As long as the yield is safe and sustainable, the higher-yielding stock may be the better option for income investors. But if you want more than just dividend income, a growth stock like Costco that has a rising yield will likely make for the better overall investment.
