Are You a Dividend Growth or Dividend Yield Investor?

December 7, 2022

Investors right now are on edge. That’s understandable given the volatility we have witnessed in stock markets so far in 2022.

While Singapore’s market has done relatively well, the world’s largest stock market – the US – has fallen from its all-time highs in late 2021.

One topic that has come back into the investor lexicon is “dividend investing”. That’s mainly down the fact that dividends offer some protection to your portfolio when markets are falling.

My colleague, Billy, has previously covered how to actually go about buying dividend stocks. But for dividend investors, of all stripes, it’s important to recognise what type of dividend investor you are too.

What do I mean by that? Well, for me, there are two types of dividend companies; growth and yield. Let me explain further.

What is a “dividend yield” stock?

Naturally, many of us gravitate towards the dividend yield of a stock when we look to invest in dividend stocks. The higher the dividend yield, the more you’ll receive back on your initial investment outlay.

However, extremely high dividend yields can also lead to dangerous capital losses.

Admittedly, there are many rock-solid dividend stocks and when I say “yield”, I refer to companies that yield upwards of 4-5%. Yet these types of companies rarely grow their dividends at a rate faster than 5-10% per year.

REIT and bank dividends provide yield

For example, many of Singapore’s real estate investment trusts (REITs) are great yield investments but their actual dividend growth rates are very low.

That’s probably attributable to the fact that REITs in Singapore are legally required to pay out 90% of their distributable income as dividends to unitholders.

So, in an environment like now – where profits might fall or margins come under pressure – there isn’t much room to keep growing a dividend with an effective dividend payout ratio of 90%.

Another great yield area is Singapore banks, which all yield upwards of 4% currently. They’re all stable and reliable franchises.

But a local bank like Oversea-Chinese Banking Corporation Limited (SGX: O39), also known as OCBC, has only grown its dividend at a compound annual growth rate (CAGR) of 6.1% over the past decade.

What about a “dividend growth” stock?

To me, a dividend growth stock is a company that has a dividend that is yielding less than 4% (usually 1-3%) but which is growing its dividend at a much faster compounded rate.

For investors, that means consistent and reliable growth in the dividend per share (DPS) of at least 10% – if not more – each year.

These types of dividend growth stocks are harder to find within Singapore, given the limited size of the total addressable market (TAM) for many companies operating here.

So, while the US does impose a 30% dividend withholding tax, the growth rate of dividends paid out by US companies means that younger investors should have at least some exposure to dividend growth stocks there.

For example, Home Depot Inc (NYSE: HD), the world’s largest home improvement retailer, has grown its dividend at a CAGR of 19.7% over the past 20 years.

To illustrate the absolute growth of that increase, in 2002 Home Depot paid a DPS of US$0.21 whereas in 2022, the company has paid out a total DPS of US$7.60.

So, by buying solid dividend stocks today, and holding them for years, investors could see their dividend completely offset any dividend withholding taxes in 10-20 years’ time.

Dividend growth or yield is down to preference

Just like broader investing, the style of dividend investing you’re drawn to is a highly personal preference.

Some people may like higher yields whereas some investor will prefer faster-growing dividends.

Generally, though, if you don’t need to retire (or require the passive income to live off) within the next five years or so, then trying to grow the absolute dividend you’re paid at a faster rate would be advisable.

At the end of the day, though, both dividend growth and yield stocks can serve a useful purpose in any portfolio.

Disclaimer: ProsperUs Head of Content & Investment Lead Tim Phillips owns shares of Home Depot Inc.

Tim Phillips

Tim, based in Singapore but from Hong Kong, caught the investing bug as a teenager and is a passionate advocate of responsible long-term investing as a great way to build wealth.

He has worked in various content roles at Schroders and the Motley Fool, with a focus on Asian stocks, but believes in buying great businesses – wherever they may be. He is also a certified SGX Academy Trainer.

In his spare time, Tim enjoys running after his two young sons, playing football and practicing yoga.

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