Putting this into practice is about a rough separation for high yield and low dividend growth versus lower yielders with high dividend growth. . A company with a 3% dividend yield would need at least 7% dividend growth to clear the bar. Likewise a high yielding company with say 6% would only need a tepid 4% growth to get over the 5+5 hurdle.
GlaxoSmithKline's 5.6% current yield combined with a 6.6% 5 year annualized dividend growth clears the 5+5 hurdle with a total of 12.2. By the same token, IBM clears the hurdle even though it has a much lower yield of 2.3%, IBM sports a 5 year dividend growth rate of 14.3% for a combined 16.6 percentage points.
Before any mathematicians jab a pencil into their eye, the 5 + 5 rule is not about mathematical precision. Its much more about orienting your frame of reference for investment selection and ongoing portfolio management - what am i looking for with this investment? What does "good enough" look like? What are the minimum expected growth rates that are acceptable given the current yield? Is a low yielder with decent growth as good an investments as a high yielder?
I did some cocktail napkin math with four scenarios
- 2% current yield with 8% growth
- 3% current yield with 7% growth
- 4% current yield with 6% growth
- 5% current yield with 5% growth
|Yield Plus Growth||2+8||3+7||4+6||5+5|
|Income - Year 1||2||3||4||5|
For Capital appreciation I tracked the growth of $100 and assumed that the shares roughly track the dividend growth and so the 2% yield wins here
|Capital - Year 1||100||100||100||100|
Then in the last scenario I combine the income plus capital plus reinvest the dividends each year.
|Total W Div Reinvested||100||100||100||100|
The ten year total returns are for all intents and purposes identical. I think this shows the value of 5 + 5 as a conceptual model. Of course, its a model not reality, but despite it breaking any number mathematical rules it holds up well as a rough guide.
There are a number of caveats here, first there is no guarantee that share price will track dividend growth, although it usually does over a long enough time scale. One of my starting points is 5 years annualized dividend growth, but just because IBM and GSK have grown their dividends in line with the 5 + 5 rule for the last five years, the future can be different. Just ask Tesco or Boardwalk Pipeline shareholders.
I still find it interesting to see that in a total return view the 5+5 thinking works pretty well and it confirms to me that both low yielders like IBM and high yielders like GSK can be worthwhile long term holdings when dividends are reinvested.