Dividend Yield and Dividend Growth
One more example is in order at the opposite end of the growth spectrum: Consolidated Edison (ED). This electric utility is notable for three things:
1. Con Ed does a superb job of keeping the lights on in New York City (notwithstanding the 2003 power failure that blacked out parts of eight states--I know, I was there).
2. It has raised the dividend on its common stock for 33 straight years--no mean feat.
3. Unfortunately, Con Ed has one of the worst dividend growth rates of any company with a lengthy streak of annual increases. Between 1996 and 2006, its per-share dividend rate rose at a paltry average of 1.0 percent per year. (See Figure 2.5.)
A low growth rate is not necessarily bad, so long as the yield is high enough to compensate. Stocks with low dividend growth prospects should offer high current yields, and vice versa--and these two numbers need to add up to something worthwhile. But in mid-2007, Con Ed's dividend rate of $2.32 and market price of $46 resulted in a yield of only 5 percent. The implications of the past (annual dividend growth of 1 percent) and present (5 percent yield) are dismal: a dividend total return prospect of just 6 percent annually. That's not much more than an investor could get with a risk-free bank CD. I may not know for sure how low of a return would still be adequate for a low-risk business like Con Ed--but I'm sure it's higher than 6 percent.
Dividend growth isn't the only variable. Stock prices change all the time, and since dividend rates are presumed to be fixed in the short run, yields change every time prices do. This is an inverse relationship: A higher stock price means a lower yield, while lower prices mean a higher yield. Were Con Ed's stock to drop from $46 to $33, its yield would rise from 5 percent to 7 percent. Assuming growth stays at 1 percent, Con Ed's dividend return prospect would rise from a questionable 6 percent to an arguably adequate 8 percent.
Either way, Con Ed's dividend is sending clear signals: Either the company's growth rate will have to be significantly better in the future than it has been in the past (and there's some reason to believe it could be), or investors are paying too much for the stock and accepting insufficient yields and total returns as a result.
