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.
Nice article on a concept similar to what is known as the Chowder Rule. BTW, a small typo in the second to last paragraph: "area" instead of "are a"ReplyDelete
Thanks FerdiS. I have seen a couple of variations on this rule, the Chowder rule as I understand it, aims for a total of 12 but then makes some exceptions for lower yielders like utilities. I think that whether its 10 or 12, the core idea and philosophy is the same, as desribed in the Chowder rule - "High Quality + High Current Yield + High Growth of Yield = High Total Return" works pretty well.ReplyDelete