Forget Yield, Dividend Growth Matters Most

 | Jul 23, 2013 02:23PM ET

Income investors had a little scare in May and June. Bond prices took a tumble and dragged down assets that have come to be viewed as bond substitutes -- including popular dividend-paying stocks, MLPs and REITs.

Now that the dust has settled and the income markets have regained some semblance of normalcy, let’s take a step back and review the case for income stocks. With the Fed’s quantitative easing eventually coming to an end and with bond yields likely to rise in the years ahead, does it still make sense to look to the stock market for income? Or might investors be better off buying and rolling over a bond ladder to meet their income needs?

A Look At The Numbers
Consider the options you had as an investor ten years ago. In 2003, the 10-year Treasury yielded 3.97%. We’ll be generous and say 4% to keep the math simple. A million-dollar portfolio invested in Treasuries would have paid out an income of $40,000 in the year you bought it…and ten years later, it still would have paid you $40,000 per year on your original purchase price. (Math purists will point out that the yield to maturity calculation is a little more complicated than that, but it’s close enough for our purposes here. We’ll assume you bought the bonds at par and that capital gains are a moot point.)

Over the ten year life of the investment, you would have received $40,000 per year. Of course, $40,000 went a lot further in 2003 than it does in 2013, but we’ll get to that a little later.

A Favorite REIT
Now, let’s do the same math on one of my favorite REITs -- Realty Income (WMT ). I included both of these names for one critical reason -- both paid comparably low dividends back in 2003. Yet despite paying a modest yield at the time, both had been serial dividend raisers for a long time -- and still are. Their stock prices have had wild swings over the years, but their dividends have been a source of rock-solid stability.

In 2003, Johnson & Johnson and Wal-Mart yielded 1.5% and 0.65% in dividends, respectively. A million dollars invested in each would have paid out $15,296 and $6,538. That stacks up pretty poorly in comparison to the $40,000 you could have received in bond interest by investing in Treasuries.

Fast Forward Ten Years
Those original million-dollar investments in Johnson & Johnson and Wal-Mart would be paying you $49,244 and $34,144, respectively. Wal-Mart’s total cash payout is still a little lower than the payout from the Treasury note, though it rose by more than a factor of five -- and will likely keep rising at a blistering pace for the foreseeable future. And again, this says nothing about capital gains -- or about the reinvestment of dividends, which would have boosted the number of shares you owned and thus your ultimate payout.