Dividend Growth vs High Yield - Pick Your Poison
I think it's imperative for investors to regularly review their investing strategy, I really do. I believe practicing what you preach is as, or if not more important as well. So... why am I writing this post? Well, call it pretentious, but I was reflecting on my investment journey so far this afternoon, and I questioned myself: "Why do I invest in/seek high-yielding stocks?"
I instantaneously rationalised: "I'm someone young with a long-term investing horizon, I can afford to take risk what!" But then it instantly hit me. Does taking on higher risk by investing in high-yielding stocks actually provide better returns?
Perhaps we should unpack things a bit first. Why do I say that I take higher risks by investing in high-yielding stocks? I believe that the market is efficient and that in the long run, share prices reflect the fundamentals of the underlying company. Since dividend yield is simply a calculation of Dividend/Share Price, if share prices dip, the dividend yield would naturally rise. Hence, we can naturally conclude that should there be an incredulous decrease in share price, it means that the market has detected a heightened level of risk associated with the stock, such as a high possibility of insolvency, dividend cuts, or inconsistent earnings.
On the flip side, we have dividend growth investing. Such an investing strategy focuses on investing in large blue-chip companies that regularly increase their dividend, increasing one's income without any need for reinvestment. Typically, capital appreciation is also associated with this strategy, as increasing dividends may signify consistent, stronger YoY earnings.
Okay, I get that it's hard to compare which is better than just a bunch of words jumbled up, so I'm here to provide a visualisation.
Introducing DBS Bank (SGX: D05), with a 5-year average dividend yield of 4.249%, and a ten-year compounded annual growth rate (CAGR) of 8.36% and 9.9% for share price and dividend payout respectively. This counter is most definitely familiar with the Singapore investing population, known locally as the Singapore Government's banking arm, it's the poster child for dividend growth investing, with a high return on equity (ROE) and a growing, stable business, it is no wonder why it's commonly touted as a "must have" for a retiree's portfolio.
Next up, we have Keppel Infrastructure Trust (SGX: A7RU), a company that manages core-infrastructure assets that pay a rather stable high dividend yield. Unsurprisingly, it's known as a cash cow by income investors benefitting from those large cash flows. It boasts a 5-year average dividend yield of 6.761%, and a ten-year CAGR of 1.84% and 4.44% for share price and dividend payout respectively.
Let's pin them up against each other and see who actually wins...
Overall, it's clear to see that DBS Bank is the winner, with and without DRIP. That being said, I would reckon that it would be wise for retirees to move their funds into high-yielding stocks should they need the high yield immediately to live a comfortable life. But it seems too simple, doesn't it? If that's the case, why don't people just invest in dividend-growth stocks?
Great question, hypothetical reader. I don't claim to know all the answers, but I think I can give a few guesses as to why.
Firstly, the stock market isn't so simple. You can't just invest in a counter and know exactly what its CAGR will be in the future. In the example above, we are simply extrapolating past results to derive an expected figure, but it isn't set in stone. You could invest in a dividend growth company, but it doesn't mean that it'll perform better than a high dividend-yielding stock. In fact, if there's a substantial change in management composition or strategy, they might be flushing capital down the drain. Capital that should have been redistributed back to shareholders. On the contrary, high-yielding stocks give a lot of control to shareholders, allowing them to utilise capital as they see fit.
Another possible reason could be that just because a stock is high yielding, doesn't mean it isn't a dividend growth stock. What do I mean? Well, Warren Buffet has frequently been quoted as saying this:
"Price is what you pay, and value is what you get."
I wholeheartedly concur. Could the high yield of a stock simply be the market mispricing the counter? Well, you might come to that conclusion if you do your due diligence. Fu Yu Corporation, despite yielding an insane 7%, has historically risen dividends, albeit not that consistently. Overall, as long as a stock seems undervalued to you, I think it's rather irrelevant whether the ticker is "high yielding" or "dividend growth". Capital gains can be realised in any situation too. Mis-priced, high-yielding stocks could simply experience a price rebound in the short term, providing an opportunity to realise capital appreciation.
Lastly, quintessential dividend growth companies are typically large corporations that have already penetrated most of their respective markets. Imagine if everyone in the world already had an Amazon subscription, I'd take a gander and say that it'll be hard to continue growing. People want substantial rewards and are willing to take on substantial risks to achieve them.
So, here are some of my closing thoughts regarding my current investment strategy.
I think I've conflated risk with reward potential. I used to think that I should focus on high-yielding stocks despite the supposedly high risk since I thought I'd be rewarded for my bravery. Moving forward, I think I'll still dabble in high-yield stocks, but I certainly will pay more attention to the so-called "boring" blue chip companies of Singapore.
Author's Note: In terms of the calculations, I initially wanted to see if there would be a difference if I reinvested the yield spread between the two tickers while keeping track of the dividends between the two. For example, let's say I have stocks A and B yielding 4% and 9% respectively. Assuming stock A is a dividend growth stock, I would reinvest the yield spread between the two (5%) for stock B and see whether the dividends paid out by stock B would supersede stock A's. I haven't found any software/website to try this idea with, but I may make a follow-up post and calculate such figures manually. No promises though.
Think this article is something you'd want more of? Subscribe here using your email to get notified about my latest blog articles, I'd truly be grateful!
Disclaimer: Please take everything published within this blog with a pinch of salt. Nothing I say here should be misconstrued as any form of financial advice whatsoever. In fact, I am probably the absolute last person you should approach for any sort of advice. All self-computed figures are calculated to the best of my ability, but I cannot guarantee they are 100% accurate, and I am not liable for any investment decisions made based on my content.
Thank you for reading my blog, and I hope you have learnt something, no matter how seemingly minuscule. I would greatly appreciate it if you took the time to check in regularly as such posts take a decent chunk of time to dish out, ciao!
Comments
Post a Comment