Dividend Income Versus Dividend Growth

Income Tax Cocktail (Photo credit: Kenn Wilson)

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. ... Continue to read.

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