Dividend Yield Should Not Drive Your Stock Selection Process

(Last Updated On: September 16, 2017)

I received an email from a new follower asking me for my opinion regarding Southern Company (NYSE: SO) given that it has a dividend yield of ~4.75%. I quickly looked at the 5 year compound average dividend growth rate (“CADGR”) and noticed an anemic 3.50%.

This brings me to the objective of this post which is to demonstrate that dividend yield should not drive your stock selection process. I will compare SO’s projected dividend income stream with that for 3 companies with far lower current dividend yields but much higher CADGR.

The proliferation of stock screeners over the years has certainly made it far easier to identify potential investment opportunities. I suspect, however, that there are countless investors who rely on the results from their stock screening process and do little, if any, additional research before placing their “buy” or “sell” orders.

I support the use of stock screeners and occasionally use them. That, however, should merely be a small step in the entire investment analysis process. Once your stock screener has narrowed the universe of companies into a subset of companies that fit your search parameters, it is imperative you learn about the company and the industry. Analyzing the company’s financial statements, stock charts, and dividend history is strongly recommended but you should also try to understand how the industry is evolving and have some knowledge about the competition.

Having said this, the purpose of today’s post is not to analyze SO but to demonstrate how focusing exclusively on a company’s current dividend yield prior to making an investment decision is not recommended.

I have created the enclosed spreadsheet on the basis of an investor having $10,000 to invest. The task at hand is to determine whether these funds should be used to:

  • acquire shares in SO because of its attractive dividend yield;
  • invest in other companies which have far lower dividend yields but more attractive CADGRs.

Dividend Income Analysis Using Various Compound Annual Growth Rates

I gathered the current calendar year’s dividend data from each company’s website; the web addresses are provided in the spreadsheet if you wish to verify the data. Please note the dividend history page for Broadridge, a company about which I recently wrote a post, is incorrect. I have written to the company about the dividend history data being outdated but no change has yet been made to the site.

In order to obtain the 5 year CADGR, I used Guru Focus. I entered the ticker symbol in the search field and selected the dividend tab.

The projected dividends reflected in the enclosed spreadsheet presume each respective company will grow its dividend at a rate that is consistent with the most recent historical 5 year CADGR. I have no way of determining whether this will actually occur but for the purpose of this analysis I will proceed on the basis of the historical growth rate being carried forward.

I specifically chose to compare Southern Company with Church & Dwight, Hormel, and Broadridge. I own shares in these 3 companies and know their dividend yields are sub 2%. They do, however, have dividend growth rates in the mid and upper teens. SO, however, has a far greater dividend yield but the dividend growth rate is only 3.50%.

While SO currently generates considerably more dividend income than the other 3 companies and its annual dividend stream will continue to exceed that of the other 3 companies for the next few years, note how the annual dividend income gap narrows. If my metrics turn out to be reasonably accurate over the next few years, the current low dividend yield companies will eventually end up generating more dividend income on an annual basis than SO.

While this analysis demonstrates that low dividend yield companies should not be overlooked, I want to reiterate that your investments should be tailored to meet your goals and objectives. If you need dividend income to meet your current living expenses then SO is probably a more suitable investment for you than the 3 companies I selected for comparison purposes.

Personally, I have a diversified portfolio consisting of companies which offer attractive dividend yields but lower CADGR and companies such as those used in the analysis. At this stage, I do not intend to collect a government pension until I reach 71 years of age. My portfolio, therefore, is structured to generate dividend income to cover living expenses while also providing growth that more than offsets inflation.

Drop me a line if you found this topic to be of interest. I would really like to know how you decide what companies belong in your investment portfolio.

Note: I sincerely appreciate the time you took to read this post. As always, please leave any feedback and questions you may have in the “Contact Me Here” section to the right.

Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.

Disclosure: I am long CHD, HRL, BR.

I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.