A public corporation exists to do one thing – provide profits for its shareholders.  For corporations who pass a portion of their earnings on to shareholders in the form of dividends those earnings can either be used for short term payments in the form of quarterly dividends or long term payments in the form of dividend growth.

Whether an individual company decides to emphasize current dividends over dividend growth depends on many factors but how efficient they are at turning earnings into growth is reflected by their return on equity (ROE).  ROE is a measure of how much a single dollar of investment capital or revenue can be turned into a dollar of profits.

High ROE corporations are very efficient at turning capital into growth while low ROE corporations are very inefficient at turning capital into growth.  As such, the value of putting a dollar of earnings toward dividend growth vs. using it to increase dividend yield can vary significantly from company to company and from industry to industry.

But, the basic choice remains – what proportion of earnings should be distributed to shareholders today and what portion should be used to grow future earnings so there will be more profits to distribute to investors going forward.

For you as an investor, your time horizon governs which choice you should consider most important as you’re evaluating dividend paying stocks in which to invest.  For a short term position where you hold the stock for only a few years current dividends are how you’re going to profit from the investment so a higher dividend yield will provide better results for you.  This is also true if you’re using dividend paying stocks for income as dividend growth isn’t what you’re using to pay your bills!

For long term investors, dividend growth can be much more compelling than a high current dividend yield.  A low dividend yield that grows modestly but consistently each and every year will not only increase dividend payouts but push the per-share price of the stock higher as well.  When you factor in the additional shares that will have been bought if dividend payments are reinvested, an affordable position in a low dividend yield stock today can grow substantially as time goes by.

But, dividend growth is never guaranteed so today’s low dividend yield stock may never compound dividend growth to the point where it’s worth accepting those lower dividend payments along the way.  Ideally you’re looking for a balanced mix of current dividends and future growth but, in the end, it comes down your own individual investing strategy and your time horizon.

If you’re using dividend payments for income then getting the highest dividend yield for your investment dollar is paramount.  If you’re using dividend investing to grow a retirement portfolio that you won’t need income from for several decades, choosing a lower dividend yield in exchange for more substantial dividend growth going forward could put you much farther ahead in the long run.

If you’re somewhere in the middle, pick whichever strategy makes the most sense to you but, in any case, do your research and make sure that if you’re picking a stock for dividend yield that it’s well positioned to deliver that yield and if you’re picking a stock for dividend growth that its prospects for delivering on that growth have a basis in fact.  Although dividend investing is more fundamentals based than general equity investing, when it comes to projecting into the future it’s often anyone’s guess.