Dividend Income Versus Dividend Growth
While the higher yields from high payout ratio stocks are enticing, stocks that offer dividend growth are generally higher quality.
Just because a stock pays a dividend, it doesn't mean that its growth days are behind it. Apple (AAPL), which plans to pay its first dividend later this quarter, is still projected to grow earnings by 22% per year over the next five years. Apple plans to pay a quarterly dividend of about $2.65 per share. That equates to a dividend payout ratio of about 26% of earnings, based on forecasts of $10.33 in per share earnings for the next quarter and a low dividend yield of about 1.9%. The conventional wisdom is that the higher the payout ratio, the lower the future earnings growth.
Let’s say that a firm has $100 in capital and income of $10, for a return on capital of 10%. If it pays out 70% of earnings as a dividend, it would pay a $7 dividend and keep $3 as additional paid in capital. The next year, capital starts out at $103, and if we assume that the firm earns a 10% return on capital again, earnings would grow to $10.30 for 3% earnings growth. The more earnings the firm keeps, the greater the capital base and the faster earnings will grow. For example, if the payout ratio had been only 20%, the capital base would have grown to $108 and the 10% return on capital would result in earnings of $10.80, for 8% earnings growth. Of course, the higher the payout, the higher the current dividend yield is likely to be. Because utilities companies typically have steady capital needs with few growth opportunities, they tend to have high payout ratios and higher dividend yields, while tech firms have historically had low payout ratios as they often have many growth opportunities.
Michael Rawson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.
Transparency is how we protect the integrity of our work and keep empowering investors to achieve their goals and dreams. And we have unwavering standards for how we keep that integrity intact, from our research and data to our policies on content and your personal data.
We’d like to share more about how we work and what drives our day-to-day business.
We sell different types of products and services to both investment professionals and individual investors. These products and services are usually sold through license agreements or subscriptions. Our investment management business generates asset-based fees, which are calculated as a percentage of assets under management. We also sell both admissions and sponsorship packages for our investment conferences and advertising on our websites and newsletters.
How we use your information depends on the product and service that you use and your relationship with us. We may use it to:
To learn more about how we handle and protect your data, visit our privacy center.
Maintaining independence and editorial freedom is essential to our mission of empowering investor success. We provide a platform for our authors to report on investments fairly, accurately, and from the investor’s point of view. We also respect individual opinions––they represent the unvarnished thinking of our people and exacting analysis of our research processes. Our authors can publish views that we may or may not agree with, but they show their work, distinguish facts from opinions, and make sure their analysis is clear and in no way misleading or deceptive.
To further protect the integrity of our editorial content, we keep a strict separation between our sales teams and authors to remove any pressure or influence on our analyses and research.
Read our editorial policy to learn more about our process.