A never ending discussion in the field of dividend investing is whether you go for high yielding stocks or dividend growth stocks. Recently, I had a few discussions on Twitter about this topic. Because it is a question many investors have – amateurs and experienced investors alike – I decided to write a Weekly to compare both strategies.

Summary and key takeaways from today’s Weekly
– There are mainly two opposing camps of dividend investors: growth vs. high yield.
– However, I am afraid that many, especially newer and younger investors, often invest based on historical titles and promotion by influencers, instead of fundamentals.
– I prefer higher yielding dividend stocks where I checked the fundamentals and where I can be sure that the dividend is well covered

Not only in stock investing in general, you won’t find a one size fits all strategy.

The reason is, there is none.

The sub-topic of dividend investing which is growing in popularity, especially among younger investors, often opens up the question whether you should go for slowly or no growing and high yielding dividend stocks now or forgo some of the yield in the present and instead enjoy high increases every year (i.e. with a lower starting yield).

The former is often connected to more mature, slowly or hardly growing companies with strong cash flows, but not much room for massive payout increases in the magnitude of let’s say 10% or 20% a year.

To the contrary, the latter offers way lower current yields – for example 1.5% or 2%, maybe up to 3% – but due to the structural growth of the underlying business that enables dividends to be increased, at some point in time these investments should overtake the high-yielders and offer a higher so-called “yield on cost”.

This applies only to financially and operationally healthy businesses.

Both strategies have their pros and cons.

Of course it depends on your personal circumstances which strategy fits better to you.

If you need cash flow from dividends now, because you’re in retirement, you hardly will go for a stock that yields 2% but promises growth over the next 10–15 years.

Conversely, many younger investors are opting for a dividend growth strategy in order to one day have stocks in their portfolios that will give them a double-digit return on their initial investments. One such famous beacon for many is Warren Buffett’s investment in Coca-Cola (ISIN: US1912161007, Ticker: KO) that pays him a yield of more than 50% on his initial purchase.

In this Weekly, we are going through both strategies.

First, we will define what a high yield is in the first place. Second, we will have a look at the famous dividend titles and question dividend safety. Third, we will also have a look at some calculations to examine how long it could take for a dividend growth strategy to get the upper hand.

Finally, I will also answer the question from my subjective point of view – however, this will be solely my own opinion.

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When does a dividend stock have a high yield?

There is no sort of scientific answer to this question.

Depending on whom you ask, some will tell you that everything north of 5% is a high yield, while others will already draw the border at 3%.

To get a first impression, I posted (in German) a slightly provocative tweet where I said that stocks with dividend yields of less than 4% aren’t “real” dividend stocks for me (the google translation is improvable…):

Until now, this tweet generated nearly 3,000 views and several comments with vivid discussions.

What was clear from the outset was that my tweet would create two camps with opposing views. I received many confirming likes, but also analogous comments like:

• higher yields are riskier
• a high yields is a sign for operating problems
• I prefer safety instead of volatile dividends
• growth is more important than high yields
• one day my yield on cost will be higher
• that’s not true
• good companies don’t have high yields
• and so on…

Not everything was founded and fact-based, but in some cases rather emotional. Most people, however, made valid points, others only expressed their opinions without going into deeper details.

What this shows is that there is no clear answer to the question from the headline.

But what I read out of the discussions in my self-experiment was that 3% seems to be a magic number, somehow. With a broad-brush approach, I can conclude until here from my observations:

• Everything below 3% with rising payouts is often considered a high-quality dividend growth stock, as long as the dividend is increased on a yearly basis – no matter the pace of increases. The motto is “quality has its price”.
• also stocks with less than 2%, or even closer to 1% can be seen as dividend growth stocks as long as the payouts are rising fast enough (usually in the double digits, also including massive increases of 30% or 50%).
• Above 3% is a grey zone. For some, it is already somewhat like a “higher yielding dividend growth stock”. For example REITs or utilities can be found here.
• above 4% and definitely above 5% more comments about low underlying growth and higher risks arise.

What you don’t necessarily find so often (exceptions apply) are the aspects of payout ratios or free cash flow coverage. These are substituted by terms like “safety” or “dividend history”.

That’s what I could observe personally.

Other sources, like Yahoo Finance have tried to answer this question, too:

This article is already around two years old and thus not everything applies 1-1, today.

For example, they write that to assess the relative attractiveness of a dividend yield, it should be compared to the average dividend yield of the S&P500 or the US treasures. Everything at least in line or even above the yields these two benchmarks offer, is considered attractive.

During most parts of the last decade this was easily done. But the playing field has changed somewhat since 2022.

While the S&P500 still has a below historical average yield of less than 2% (1.7%, see here), in the meantime yields of the US treasuries have increased dramatically over the last twelve months. You can buy bonds with short durations with yields of around 4%. This would mean that stocks with less than 4% or 4.5% dividend yields are overpriced, because generally stocks are seen as riskier than bonds, especially government bonds.

While this has long been a valid approach, it somehow seems to have gone lost among the younger investors. When I look at the dividend YouTubers or Twitter gurus, most of them often show the same stocks, where most have lower yields than the treasuries.

Dividend titles and dividend safety

You can also read a bit more here and here.

Often used justifications for investments are that these companies have long streakes of dividend payments and even increases. To further cement a status, some stocks even have titles attached to them like “dividend arisotcrats” (more than 25 years of successive yearly increases) and even “dividend kings” (50+ years of successive yearly increases).

There are also “contenders” and more lower-rank attributes, but let’s leave it this way.

But it is outright dumb and amateurish to just invest based on such a title.

Why?

Every streak holds for so long until it breaks. Just this week, we got a perfect example:

V.F. Corp. (ISIN: US9182041080, Ticker: VFC), known for its Timbaland shoe brand, was a dividend king. It achieved this rank just last October with a symbolic single-penny increase of its dividend from 0.50 USD to 0.51 USD.

Until a few days prior, when it announced a massive 40% cut – just one quarter after achieving its highly regarded status:

A cold shower for those who bought the seemingly juicy 7% yield before.

Prior, this stock has been appraised as having achieved the highly recognized status of a dividend king with its 50th consecutive dividend increase (see the dividend history here).

There are many such examples where stocks are regarded – and even more dangerous, presented to people in good belief – as high quality, infallible and indestructible, just due to a streak of the past.

However, this doesn’t question the sustainability of the dividend.

In the following, I picked such an example. I only picked the following blog with its relatively young article from end of December, because it has been shown to me first in the search engine, not to discredit the author.

To be fair, he also says in this article that he doesn’t invest due to several uncertainties (management, guidance, macroeconomic factors) and he has put much effort into his work.

The author writes a long analysis and also shows many financial numbers.

However, the underlying tone is that this a good dividend stock and nothing can go wrong due to its dividend history.

Here is an excerpt from the end:

As you see, in the last sentence he raises some doubts. But not concerning the dividend. He is also comfortable with the high debt load (although slightly above his personal target level) and does not question the sustainability of the dividend.

For me, it is a dangerous assumption when just looking at such headline statements. Sure, the likelihood of a future payout might be higher if a certain dividend history is in place. But it is no guarantee.

Every company can cut its dividends.

As this article here suggests and as I am preaching for as far as I can remember, the safety of a dividend is the most important factor. The higher the yield the better, but safety and sustainability first.

Whether high yield or not – the fundamentals must always be checked.

Much higher yields are often linked to either cyclical companies from the energy sector, to “sin stocks” like tobacco, other “anti-ESG” operations or an alleged indicator for operating troubles. While both can be the case, it does not have to necessarily.

Now, I show you a confusing chain of arguments, I often stumble upon.

For example, currently I personally pretty much like oil, coal and tobacco companies from an investment perspective in the current environment (regarding the first two categories, my Premium Members received already a research report each).

These are established businesses with strong cash flows and high dividend yields. Of course their balance sheets are strong and clean. And what is often not said: They also have long dividend streakes and very seldom cut their dividends.

But that’s not the point. Many of them are financially healthy and can keep up their payments.

However, what I find interesting, is that companies that really have operating trouble due to bad management decisions as well as over-leveraged balance sheets like:

• 3M (ISIN: US88579Y1010, Ticker: MMM)
• Intel (ISIN: US4581401001, Ticker: INTC)
• Verizon (ISIN: US92343V1044, Ticker: VZ)
• or the discussed V.F. Corp. from above

(which I featured here and here for potential dividend cuts, unfortunately without VFC), are passionately and frenetically defended as being high quality that will never cut their dividends. However, their stock prices are at multi-year lows, suggesting operating problems. 3M is near its ten year low, V.F. has been even below that before the cut.

The reason for the defense? Because these companies have been paying dividends for so and so long.

Aha.

Fundamentals and financials don’t matter?

For me, there is another obvious reason. Many of these stocks are defended, because their investors are under water with them. They do not want to admit a mistake and hence are vigorously defending their positions, despite the numbers speaking against them. They just average down and hope for a turnaround someday.

I wrote months ago why it is important to let losers go and what it does for your mindset in my article: “Why you need to remove your portfolio losers regularly” (see here).

This is one of my most important pieces so far, because it explains the psychology.

With the risk of sounding like a broken record, I yesterday tweeted again that there will be a crude awakening as many companies from a business and financial health perspective are not prepared for higher interest rates for longer:

For the sake of this article, let’s take into the next section that:

• the most important factor is dividend safety; safety is not defined by historical series, but by sound financials.
• up until 3% you should have quality dividend companies or at least many view it this way.
• Above 4% and certainly above 5% the high yielding area starts, where many feel uncomfortable and “insecure”.

I am now going to do some calculations to find out and show how long it could take for dividend growth companies to finally overtake high yielding ones.

High dividend yield or high dividend growth?

For simplicity reasons, I left out any taxes, transaction costs and assumed that the side-mover never increases its dividend, which in practice is unlikely. But let’s take it this way.

To not bore you with too many graphics and statistics, I just shorty explain my approach.

I created several sheets where I compared virtual stocks with different dividend yields with each other. My goal was to answer two main questions:

• when will the yield on cost of the dividend growth company be higher compared to the high yielding stock?
• how long will it take until the high-grower has paid in total more dividends than the high-yielder?

It might sound like the same, but there is an important difference.

While question number one is obvious (when does the grower for the first time overtake the side-mover in a single year?), the second question counts all yearly payments, adds them up and then tells us when the grower will have paid more dividends in total on a cumulative basis.

This is important, because for as long as the yield is higher for the side-mover, the accumulated dividends remain higher and the difference gets bigger until finally the grower overtakes with its then higher yield on cost and starts to close the so far increasing gap (until they got on par) of the past.

I created in total twelve models with 24 charts:

• the dividend growers start from 1%, 2% or 3%
• the dividend gets increased by 10% or 15%
• the high yielder starts at either 5% or 6% without growing the dividend ever

This gives us in total twelve models or possible combinations. And every case of the twelve has two charts (question one and question two).

To not show you 24 charts in total, here are two examples. I will put the other results into a single table after the charts for a better overview and to draw a conclusion.

You have to look in every case for a cross of the blue line or column from underneath.

So, question one: When will a 3% yielding growth stock (10% dividend increase every year) have a higher yield on cost compared to a 5% high yielder (no increases)?

The answer is: in year six the yield on cost after six consecutive increases by 10% will reach 5.3% and for the first time be higher than 5%.

How does it look regarding question number two? When will all accumulated dividends paid be higher for the growing stock?

The answer: It takes somewhat longer, because until year six the total dividends are lower for the grower and only from year six on start to close the gap. While in year nine they are both head-to-head, in year ten the grower finally has paid in total more dividends than the 5% yielding side-mover.

This was rather a realistic example, at least regarding the starting dividend yields.

It is very hard to increase a dividend every year by ten percent!

Now, let’ look at a more dramatic difference. Starting yields are 2% and 6%, the yearly dividend growth is 15%:

Here, in year eight the yield on cost reaches 6.1% and overtakes the 6% side-mover.

But what about the total dividends paid? Only in year 13 will you have received more dividends in total in this case.

^{source: my own calculations and graphics}

I think you understand the basic mechanics.

Now, here is the table will all combinations and results:

To repeat, I think I used rather optimistic data in favor of the dividend growing proponents. Two main points are holding back the potential of high yielding dividend stocks in my examination:

• the high yielders are not growing their dividends at all – this will be seldom the case in practice
• the dividend growers manage to keep up very high dividend growth rates in all years – 10% every year is already not a sure thing, but a dividend growth of 15% every year, especially from a higher base, will be next to unlikely to find

After lots of data, here are the most important results I can see:

• self-explanatory, but nonetheless: a higher starting yield massively shortens the time that is needed to overtake the high-yielder – you can influence this aspect if you buy only when the yield is comparatively higher, e.g. during a correction
• a higher growth rate also works in your favor as a dividend growth investor – but you cannot influence this factor!
• a higher yield on cost is one thing, but what you really want is a higher accumulated dividend in total – this often overlooked point in this model nearly doubles the time until the dividend grower takes the lead
• only if you have a rather high starting yield of at least 3% AND a high growth rate of at least 10%, it takes less than ten years until the dividend growth strategy has paid in total more dividends than a high yielding stock – but if you go above 6% it will be at least ten years in this model

What is clear without surprise is that a higher starting yield works in all cases in your favor.

But to be honest, haven’t I done the calculations above, I would likely have estimated shorter timeframes, especially for the second question regarding the total accumulated dividend payments.

I haven’t seen anyone of the dividend growth “mentors” and practitioners mentioning this second point. They only focus on a higher yield on cost, but forget that it takes nearly twice as much time – under the requirement that the growth rates don’t fall – until also the accumulated dividends overtake the high yielding stocks.

With these results, it is hard to justify an investment in a stock like Coca-Cola today.

Although the payout is rather safe at the time, the current starting yield is 2.95%, let’s say 3%. The last time they raised their dividend by (nearly) 10% was in 2014. Since then, it is only been raised by a penny or two or up to 5% – but also less! You can see the dividend history here.

Hence, for me, the result is crystal clear: I will continue – like I have already done without thinking too much about this topic until recently – to point my binoculars for (much) higher yielding stocks, as I have done already with the companies I presented to my Premium Members.

My main argument is that is way easier to check a company for its ability to pay a (higher yielding) dividend for a few years, than to ensure a high double digit growth rate of a dividend for years to come. And for this growth strategy to work, you need at least around ten years of high growth, as I’ve shown above to overtake a high yielding dividend stock.

I don’t see any attractiveness in fishing where others are already sitting.

For example, the latest stock that I featured, a German Dax company (see the corresponding Weekly here), is raising its dividend nearly every year (exceptions apply). I guess with the announcement of the yearly results for 2022, they will also raise the dividend again by around 10% after a strong last year (they raised the guidance with Q3 results). Likely, they will have a dividend yield of 5% then.

And yes, you read correctly. There are also high yielding stocks that raise their dividends by double digits.

Isn’t that an interesting combo?

Now tell me, with a 5% starting yield and a raise nearly every year, why should I go for likely overvalued stocks that only offer 2% or 3%? I don’t want to wait 20 years (I haven’t done the calculation, just a gut feeling), until – only under optimal circumstances maybe – the fast growing company overtakes the higher yielding counterpart?

No, thanks…

Conclusion

There are mainly two opposing camps of dividend investors: growth vs. high yield.

However, I am afraid that many, especially newer and younger investors, often invest based on historical titles and promotion by influencers, instead of fundamentals. Especially now with higher interest rates, those companies with high debt will be forced to cut their dividends – no matter any title.

I prefer higher yielding dividend stocks where I checked the fundamentals and where I can be sure that the dividend is well covered for the time being, instead of just buying by some obscure “dividend titles” and allegedly feel safe while being flying in the blind and hoping for strong yearly raises for the next decade.

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