Cocktail napkin math on 5 plus 5 dividend yield and growth

One of the main metrics I use is the simple 5+5 rule that I first came across in Daniel Peris' excellent book Strategic Dividend Investor. The 5 + 5 rule looks for a combination of dividend yield and dividend growth. So the total should equal 10 percentage points, for example 5 percentage points of current dividend yield plus 5 percentage points of annual dividend growth.

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

First cut is income only and 5% current yield wins here, more than double the income at the end of the decade (though not double on cost)

Yield Plus Growth	2+8	3+7	4+6	5+5
Income - Year 1	2	3	4	5
Year 2	2.16	3.21	4.24	5.25
Year 3	2.33	3.43	4.49	5.51
Year 4	2.52	3.68	4.76	5.79
Year 5	2.72	3.93	5.05	6.08
Year 6	2.94	4.21	5.35	6.38
Year 7	3.17	4.50	5.67	6.70
Year 8	3.43	4.82	6.01	7.04
Year 9	3.70	5.15	6.38	7.39
Year 10	4.00	5.52	6.76	7.76
Total	28.97	41.45	52.72	62.89

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

	2+8	3+7	4+6	5+5
Capital - Year 1	100	100	100	100
Year 2	108.00	107.00	106.00	105.00
Year 3	116.64	114.49	112.36	110.25
Year 4	125.97	122.50	119.10	115.76
Year 5	136.05	131.08	126.25	121.55
Year 6	146.93	140.26	133.82	127.63
Year 7	158.69	150.07	141.85	134.01
Year 8	171.38	160.58	150.36	140.71
Year 9	185.09	171.82	159.38	147.75
Year 10	199.90	183.85	168.95	155.13
Total	1,448.66	1,381.64	1,318.08	1,257.79

Then in the last scenario I combine the income plus capital plus reinvest the dividends each year.

	2+8	3+7	4+6	5+5
Total W Div Reinvested	100	100	100	100
Year 2	110.16	110.21	110.24	110.25
Year 3	121.31	121.36	121.35	121.28
Year 4	133.53	133.53	133.39	133.13
Year 5	146.93	146.81	146.45	145.86
Year 6	161.63	161.29	160.59	159.54
Year 7	177.73	177.09	175.90	174.21
Year 8	195.38	194.30	192.46	189.96
Year 9	214.71	213.06	210.39	206.84
Year 10	235.88	233.48	229.77	224.94
Total	1,597.25	1,591.13	1,580.54	1,566.01

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.