Now comes the part that most people miss. Our dividend yield ten years from now will be the then current dividend divided by our purchase price. Today JNJ is selling for $62 per share. Thus, based on today's price, if JNJ does increase its dividend at a 7.2% rate over the next decade the yield on today's price would be 3.93/62=6.33%.
So does it mean that we will make a cash on cash yield of 6.33% if we hold JNJ for the next decade? No, it won't be quite that good. You have to remember that it will take 10 years to produce the 6.33% dividend yield. To find the precise rate of return would require doing an internal rate of return calculation. We can, however, do a simple calculation that will give us a good idea of what we will make for JNJ over the next decade. If we average the starting and ending dividend yields, we'll achieve a ball park idea of the cash on cash return over the next 10 years. (3.20%+6.33%)/2= 4.77%.
So when we compare JNJ common stock with a 10-year T-bond, we should take into consideration that JNJ's dividend income will grow, while the income from the T-bond will be static.
There is certainly risk that JNJ won't hike it dividend by our projected rate, but I would argue that there is just as much of a chance that the dividend growth will be higher than our example. So for my money, JNJ, as a pure income investment, will provide a better return over the next decade than a T-bond just from the dividends alone.
However, as they say on late night TV, "But wait, there's more!" JNJ is not only an income security, it is an equity security. Therefore it's price will fluctuate over the next 10 years along with its prospects. At first that might swing your investment choice back to the bond. But consider the following, if JNJ's current 3.2% dividend yield is still in effect 10 years from now, and its dividend has, indeed, doubled, then its price will also double to near $124 per share. The computation for this is straight forward: ending dividend (3.93) divided by ending dividend yield (3.2%). If that is the case, then our total return for the period would approximate 10.5% per annum.
I realize there are a lot of moving parts in this discussion and that may make your eyes roll back in your head. Believe me, however, it is worth your time to get your mind around the simple math that is the basis of the Hidden Power of Rising Dividends.
We have owned the stock for many years. Do not buy it because we own it. This blog is for information purposes only.