The last six weeks have shown that trying to guess the direction of share prices is a tough way to make money in the stock market. The previous two years made it look easy to generate great profits in the market. The reality is that the stock market is much more likely to be like the last two months. If you are a long-term investor with the goal of building wealth and income to support a comfortable future, you need a plan that is not based on guessing and chasing stock prices.
Income and total return focused investors have a powerful mathematical tool that few realize exists. The math is what happens between stock yield and dividend growth. Here is how it works. If a company increases its dividend, for the stock yield to stay the same, the share price must increase by the same percentage as the percentage increase of the dividend boost. Let me demonstrate with an example.
A stock yields 5% and the dividend is increased by 5%. The new yield is then 5.25%. For the stock to stay at a 5% yield, the share price must move up by the same 5%. The result is a 5% dividend income plus a 5% share price gain for a 10% total return. In the short to intermediate term, this share price to dividend growth relationship is not apparent. Too many short term “news” items pull share prices in this direction and that. Over the long term, history shows that the average annual total returns from quality dividend growth stocks end up very close to the average yield plus the average dividend growth rate.