How to Choose Between Income and Growth

If you have decades to invest, growth stocks can boost your total returns more than mature dividend stocks that pay 3-4% dividend yields.

Here are examples to illustrate what I mean.

Fortis Inc. (TSX:FTS) is a regulated utility that has stable, predictable returns. It typically yields between 3% and 4%, and income investors hold it for its safe, growing dividend.

On the other hand, growth-oriented stocks, such as Alimentation Couche Tard Inc. (TSX:ATD.B), have low dividend yields. Couche Tard yields less than 1%. However, its growth potential is greater and can more than compensate for the lower income with growth that leads to above-average capital appreciation.

Income and total returns comparison

In the decade that ended on August 31, 2016, Fortis’s total rate of return was nearly 110%, which equated to an annualized rate of return of 7.7%. In those 10 years, dividends made up nearly 22% of the 110% returns.

In that same period, Couche Tard’s total rate of return was 784%, which equated to an annualized rate of return of 24.4%. In those 10 years, dividends only made up 1.7% of the 784% returns.

Different growth rates

Fortis has about 94% of regulated assets (69% electric and 25% gas) serving more than three million customers. Regulated assets imply regulated returns. So, its returns are stable and predictable but are capped.

Its most recent acquisition, ITC Holdings, is expected to close by year end (subject to regulatory approvals from FERC and multiple states). ITC is a quality electric transmission utility in the U.S. It will diversify Fortis by product offering and will add eight more states to its portfolio. As well, the transaction will enhance Fortis’s regulatory diversity.

Including the accretive earnings expected from ITC, Fortis expects to grow its dividend by 6% a year in the next few years. This implies an approximate return of 9.6%, including its 3.6% yield.

Couche Tard has grown successfully by integrating more than 5,900 convenience stores from 52 acquisitions since it acquired Circle K in 2003. It’s now a leading operator in North America, Scandinavia, Ireland, and the Baltics. It also has about 8,200 stores in North America, about 2,600 stores in nine countries or regions in Europe, and nearly 1,500 licensed Circle K stores in other parts of the world.

Couche Tard recently agreed to acquire CST Brands. The acquisition is expected to close early next year and will bring Couche Tard’s North American store count to more than 10,100. As well, the acquisition will strengthen Couche Tard’s presence in Texas, which is a fast-growing and business-friendly state.

Conclusion

An investor would buy mature dividend stocks, such as Fortis, and growth stocks, such as Couche Tard, for different reasons–you could buy the former for its stable dividend and the latter for potentially higher total returns.

Fortis’s dividend yield of 3.6% is secure with a 42-year dividend-growth streak and a payout ratio of less than 70%. However, Fortis’s regulated nature caps its upside. In addition, the shares trade at a P/E of 19.3, which is fully valued.

Although Couche Tard trades at a high price-to-earnings ratio (P/E) of 22.3, it offers higher upside potential due to expected double-digit growth, which largely relies on successful acquisitions.

Couche Tard has integrated many acquisitions–large and small–successfully, and the next big one, CST Brands, with an enterprise value of US$4.43 billion, should help boost Couche Tard’s growth in the next few years.

Both Fortis and Couche Tard look fully valued at current levels and would be better buys on dips. Fortis is worth a look when it yields at least 4%, and Couche Tard is worth considering when it trades at a forward P/E of 18-19, which is a price range of $56.52-59.66 per share based on estimated fiscal 2017 earnings.