Gazing into the Future

The main goal of DivGro is to generate a reliable and growing dividend income stream. I hope to achieve a 12% yield on cost (YoC) within ten years of inception. And I hope to generate acceptable total returns exceeding the performance of the S&P 500 index.

In this post I'd like to gaze into the future, to ten years from now. If I'm disciplined and lucky, and I follow my plans and strategies carefully, what could DivGro be worth? And what can I hope to receive in dividend income?

Starting with an initial investment of $12,000 and adding $1,000 per month for ten years, I'll have a total of $132,000 invested. Of course, ending with a portfolio value of "only" $132,000 after ten years of investing would be rather disappointing. Hopefully the value of the stock market would gradually increase over time and the value of my portfolio would increase also.

Market Growth

Over the very long run, the stock market has had an annualized return rate (or Compound Annual Growth Rate, CAGR) of between 9 and 10 percent. (When adjusting for inflation, the rate drops to between 6 and 7 percent).

One can calculate the CAGR of the S&P 500 over a specified date range using MoneyChimp's calculator. I've calculated 10-year rolling CAGR's for the past 30 years. The best 10-year CAGR (1998) is 19.33%, while the worst 10-year CAGR (2008) is -1.47%. The most recent 10-year CAGR (2012) is 7.06%.

 S&P 500 Rolling Returns

Years	CAGR		Years	CAGR		Years	CAGR
1974-1983	10.62%		1984-1993	15.07%		1994-2003	11.11%
1975-1984	14.82%		1985-1994	14.54%		1995-2004	12.12%
1976-1985	14.29%		1986-1995	15.03%		1996-2005	9.08%
1977-1986	13.81%		1987-1996	15.41%		1997-2006	8.41%
1978-1987	15.37%		1988-1997	18.15%		1998-2007	5.87%
1979-1988	16.43%		1989-1998	19.33%		1999-2008	-1.47%
1980-1989	17.68%		1990-1999	18.30%		2000-2009	-0.99%
1981-1990	13.99%		1991-2000	17.59%		2001-2010	1.36%
1982-1991	17.75%		1992-2001	13.01%		2002-2011	2.87%
1983-1992	16.36%		1993-2002	9.39%		2003-2012	7.06%

Assuming a 7% CAGR over the next ten years, DivGro could generate $66,210 in capital gains by January 1, 2023.

Dividend Growth

So far I haven't considered the impact of dividends on the future total value of DivGro. Currently, the dividend yield of the S&P 500 as a whole is about 2.13%. This is rather low when compared to the median dividend yield of 4.38% over the past century. It seems like investors are accepting lower dividend payouts in favor of higher capital gains.

When selecting dividend paying stocks, I look for a dividend yield of at least 2.75%. At that rate, excluding dividend growth and dividend reinvestment, DivGro would generate $19,938 in dividends over 10 years. If all dividends are reinvested, the 2.75% yield would generate $22,051 instead. The difference is due to compounding – in this case, dividends turned into additional shares that pay more dividends...

The real attraction of dividend growth investing is that the dividends themselves grow! I look for dividend growth rates that average at least 7% over the last seven years. If that growth rate is maintained for ten years, an initial dividend yield of 2.75% would generate $31,503 without reinvesting dividends, and $36,684 if dividends are reinvested.

Since I plan to reinvest dividends, DivGro could earn $36,684 (or more) in dividend income by January 1, 2023.

Yield on Cost

My minimum requirements of an initial dividend yield of 2.75% and a dividend growth rate of 7% will not achieve my 12% YoC goal in ten years. Smaller yields require substantially larger (sustained) growth rates to achieve the YoC goal.

Even if I choose the right pairing of initial dividend yield and dividend growth rate, the magical 12% YoC would only be realized after ten years for the first stock purchase. Every subsequent stock purchase (with new capital or reinvested dividends) would likely have a different initial dividend yield, so the period required to achieve my 12% YoC goal would vary.

Nevertheless, assume I do achieve a 12% YoC after ten years. If I've faithfully reinvested all dividends, my total cost basis would be $132,000 + $36,684 = $168,684. At a 12% YoC, DivGro could be generating $20,242 in dividends after ten years.

Including capital gains of $66,210, DivGro could be worth $234,894. Nice!