3/22/2013

Reader Q&A: Are High-Yields Good For Growing Your Passive Income?

One Reader of my blog, Devirick, wrote me on Facebook a question. Here are his sentences:

“What strategies are u using To be able To live off of dividends? I’m am working on creating extra income as a monthly contribution toward dividends paying high yields around +5%”

Well it’s hard to explain in a few words. In core, I would say that I'm a long-term dividend growth investor. I buy dividend stocks with a solid growth performance and a higher capitalization - The company should be good diversified.

I say core because I put around 60% of my net worth into boring companies like Nestlé, Procter&Gamble or Coca Cola etc. (Those are my core investments). Some might say they are not boring but they are because nothing spectacular happens. The good thing is that you can count on the company as basis growth engine for your portfolio (normally with a growth in a high single-digit range).

Coca-Cola, Procter or even McDonalds have strong cash flows which they use for share buybacks and dividend payments in nearly the same amount. The ratio varies, depending on the payout policy of the company. If they grow 5% in sales, earnings and dividends could grow with a higher rate because of the share repurchases. If you count with 7%-8% dividend growth, your yield on cost doubles in 10 years from alone.

If you start buying stock with 100k, you could get around 3k in dividends. In 10 years, your income should grow to 6k but the inflation pushed prices only 30% to 50% higher.

I have around 80 companies and my average growth rate is a little bit higher than 10%. I believe it’s around 12-13% for the moment. But this should slow down if the economy weakens. The reason for the higher rate is that I bought some lower yielding companies with a stronger growth and low debt and payout ratios. 

In my view, faster growing stocks deliver you a better return if you stay longer by your investment. The risk also rises because you are no more a swing trader, you are an investor. As investor your job is to identify the long-term growth perspectives and potentials of a company without losing the feeling for the risk.

Your question to High-Yield stocks: That’s no solution for wealth in my view. Most high yielding stocks are low growing stocks with high debt levels. Look at AT&T. Sure they look good at the yield is fantastic compared to the business model but they have a big debt burden and they need really big amounts of money to grow (if it’s really possible to grow because the carrier market is still developed and market shares are distributed).

You can boost your income in a short time but you will loose this advantage over the time. If you buy AT&T shares for 100k, your gross dividend income would $4.98k but in 10 years it should only at 6k or so. This is only an example. I have no idea how fast T could grow their dividends.

What if you start with an investment of 100k that pays only 1% or 1k in annual dividends and 10 years later you receive 10k? I would prefer the second alternative. Low payout and debt ratios as well as high growth potential is the key in this example.

I hope my answers helped you to understand my investment strategy a bit more. If not, feel free to submit a comment on my Facebook-Page. I always try my best to help others.

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