The Motley Fool

Should Dividend Investors Chase High Yields or Fast-Growing Payouts?

As a long-term investor, the logic of investing for dividends seems obvious to me. You invest in dividend stocks to receive growth and an income stream (which in Singapore is tax-free) in return. However, what may be less obvious is that investors have two options when it comes to dividends; companies that have higher dividend yields but stable payouts or ones that have lower dividend yields but fast-growing payouts. The key question, then, is which one should dividend investors pursue?

Age influences style

My answer would be, it depends on your age. Retirees, or those who are nearing retirement, will naturally gravitate towards stable, higher-yielding stocks including REITs. Given their regular income streams, it’s understandable that a higher return – in terms of the absolute dividend – on your initial investment is a much sought-after commodity.

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For the sake of risk, we would expect these stable (some might say boring) stocks to deliver sustainable dividend yields in the range of 4-6%. In the case of REITs, they are legally obligated to pay out at least 90% of their profits in dividends. With other investor favourites though, such as the big three Singapore banks, the payout ratio may be lower – so in the region of 50-60%. In that sense, the latter may have further headroom to raise payouts.

However, these high-yielders all have one thing in common. They rarely grow the total dividend per share much beyond inflation each year (think in the region of c.3-5% growth per annum).

Growth and dividends

Meanwhile, stocks that are paying out a low yield given their share price, in the region of 1-2%, but are growing their annual dividends at a faster clip – by at least 10-20% per annum – offer investors a longer-term road to dividend wealth. If you’re a younger investor, identifying these types of stocks may make sense.

That’s mainly because you’ll have an investment time horizon measured in decades. A low yield, fast-growing dividend and a rising payout ratio can be a lucrative combination 20-30 years down the line. A company that can continually grow its total dividend per share paid to you while also keeping a low dividend payout ratio (perhaps in the region of 25-35%) means that the potential for management to raise its payout is that much greater versus a higher-yielding stock.

Diversify, diversify, diversify

Although age does influence style, there’s no escaping the fact that with either bucket (both high yielders and growing payers), the crucial point is to ensure you invest in sustainable dividend payers.

And who’s to say you can’t diversify? Retirees can always allocate some money towards low-yielding, faster-growing dividend payers. Likewise, millennials can add reliable REITs or banks to their stable of dividend names. Like investing itself, a diversified approach to dividends always pays out – whether that’s today or 20 years from now.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.