Friday, 2 November 2012

Importance of Initial Yield


Here’s a formula dividend growth investors should commit to memory:

Total long-term return (CAGR) = Initial Yield + Dividend Growth

Many in the investment community are adamant believers in this formula. It shows the importance of buying good quality dividend growth stocks on the cheap (i.e. with a high initial yield).

I’ve chosen SNC Lavalin (SNC-T), an engineering firm, to use as an example. Between 2004 and 2012 inclusively, the company increased dividends at a rate of 23% per annum. 2012 was a disappointment, with an increase of a mere 4.76%. Below, I assume a yearly dividend increase of 9% over the next 20 years.

Earlier this year, before all the commotion set in, people were more than happy to part ways with $55.95 for one stock. At the time, the dividend was $0.84, for a yield of 1.50%. About 6 months later, the stock hit a low of $34.36. Shortly before the low, the dividend had increased to $0.88, yielding of 2.56%.

Based on the formula above, those that bought the stock for the dear price of $55.95 can expect a long-term return of 1.5% + 9% = 10.5%. Those that waited for the low low price of $34.36 can expect a long-term return of 2.56% + 9% = 11.56%.

So, what’s the difference between 11.56% and 10.5% on a $10,000 investment in 20 years? With dividends reinvested of course. $89,160 - $73,660 = $15,500; that’s 21% more!

But most importantly, you’ll have a higher number of stocks (291 compared to 179, initially), which means more in cash dividends - @ $0.88, that’s $98.56 the first year. Imagine the difference in 20 years.

And this is why I tend to buy good firms in distress. Their stocks are all too often oversold, driving up the yield. And a year or two down the road, the problems are usually fixed.

On August 20, 2012, I bought 250 shares of SNC Lavalin at $37.24. Two weeks later, I averaged down by buying 100 shares at $34.60. My average cost is $36.49, for a YOC of 2.4%.

For over two years I held out buying SNC Lavalin because my model told me it was too expensive. When the scandals surfaced, the stock price dropped like a rock. I ceased the opportunity and bought cheap. But you have to be ready to assume the risks. And by no means are they gone.

I get a Graham Price of $26.78 and a CAPE of 38. These metrics show the stock is overvalued. However, the Average Dividend Yield shows the stock is on "sale" when under $38.65 (see table below). 

SNC
Year
High Price
Low Price
1Q
div.
2Q
div.
3Q
div.
4Q
div.
Annual Dividend
High Yield
Low Yield
2003
$17.33
$9.67
$0.0333
$0.0333
$0.0333
$0.0333
$0.1332
1.38%
0.77%
2004
$19.82
$14.17
$0.0433
$0.0433
$0.0433
$0.0433
$0.1733
1.22%
0.87%
2005
$26.46
$18.47
$0.0533
$0.0533
$0.0533
$0.0533
$0.2132
1.15%
0.81%
2006
$33.50
$25.15
$0.07
$0.07
$0.07
$0.07
$0.28
1.11%
0.84%
2007
$51.04
$30.00
$0.09
$0.09
$0.09
$0.09
$0.36
1.20%
0.71%
2008
$61.95
$26.00
$0.12
$0.12
$0.12
$0.12
$0.48
1.85%
0.77%
2009
$54.00
$26.35
$0.15
$0.15
$0.15
$0.15
$0.60
2.28%
1.11%
2010
$60.00
$41.59
$0.17
$0.17
$0.17
$0.17
$0.68
1.64%
1.13%
2011
$63.23
$38.51
$0.21
$0.21
$0.21
$0.21
$0.84
2.18%
1.33%
2012


$0.220
$0.220
$0.220
$0.220
$0.88


Stock price and dividends are per calendar year

9y ave
1.56%
0.93%
Dividends are listed in the quarter they were paid

5y ave
1.83%
0.91%







3y ave
2.03%
1.01%







5y
$48.14
$96.48







3y
$43.33
$87.44






Super Cheap
$38.65




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