Many dividend growth investors consider how long it will take a given stock to reach a 10% yield on cost (YOC). The ideal target is for a 10% YOC to be achieved within 10 years. How quickly a stock reaches a 10% YOC is a function of the yield at the time of purchase and the dividend growth rate. Math, a table, and an example all follow!
In order to determine an estimate of what the YOC of your investment will be after 10 years, you need to calculate three things.
- The starting yield.
- The dividend growth rate (DGR).
- The YOC after 10 years.
If math annoys you, as it often annoys me, you can skip all these equations and just use the table below to look up the answer.
Calculating the starting yield
This one is pretty easy:
yield = starting dividend per share / how much you paid per share of the stock
Calculating the 5 year dividend growth rate
The dividend growth rate (DGR) for 5 years is calculated using the standard compound annual growth rate formula (CAGR).
DGR = ((current yearly dividend / dividend five years ago) ^ (1/4)) – 1
Calculating the YOC after 10 years
Now for the last bit of math. Once you have the starting yield and the DGR, you plug them into the below equation to get the YOC after 10 years.
YOC at 10 years = (1 + DGR)^10 * yield
Using the table to determine YOC 10 years later
If you aren’t a fan of math, you can simply use the table below to look up an estimate of what the YOC of your investment will be after 10 years. Simply pick the starting yield from the top row, and a dividend growth rate from the left hand side. The cell that is the intersection of your chosen row and column is what the YOC of your investment will be after 10 years. Cells shaded in green are all in the 10% or greater sweetspot.
How are my investments doing?
I thought that this was a fun exercise ,so I decided to check out my dividend growth portfolio. First, I estimated the 5 year DGR using the CAGR formula above. I used my investment’s 2012 YOC for the starting yield. Then I was able to estimate what the YOC at 10 years would be. Results are listed in the table below.
Note: BP and PSX were not included in the table as they didn’t have enough data to reliably calculate a 5 year DGR.
As you can see from the table, after 10 years the predicted YOC’s of each stock range from PPL’s lowly 5.9% to LOW’s whopping 45.8%. The average of the YOCs was 11.7%. While I didn’t do any weighting, it looks like I’m doing pretty good at selecting stocks that, as a group, meet the 10% YOC by 10 years metric.
You might have noticed that LOW’s predicted YOC was really high. Sometimes stocks go through a period of rapidly increasing dividends only to have the growth rate slow down afterwards. This is likely where LOW’s is right now. This kind of growth can’t continue forever.
Because LOW had such a high predicted YOC, I decided to be a bit conservative in my estimations. So I took another average of the estimated 10 year YOCs, this time excluding LOW. I got 9.4%. Not too bad.
How reliable are these estimates?
They’re just estimates, so take them with a grain of salt. As they say in the investing world, past performance is not a gaurantee of future returns. Dividend growth may have been blazing fast over the last five years, but it might grind to halt during the next 10. The reverse is also true. Sometimes dividend growth slows down only to pick up several years later as business conditions and profits improve.
Don’t consider this metric to be the be-all and end-all of stock picking metrics. Consider it one more item in your armamentarium of analytic tools for picking great stocks.
Disclaimer: I’m long all the stocks mentioned or listed in this post. I’m also short INTC.
Readers: How does your portfolio stock up against the 10 by 10 metric? Do you even use it? If so, how much weight do you assign to it?