The personal income tax on dividends is generally higher than that on capital gains. This differential will presumably lead high-income individuals to prefer, hence bid up, the shares of companies that emphasize capital gains rather than current dividend yield. And it is indeed the prospect of capital gain, rather than growing dividends, that justifies this emphasis; on the basis of accumulating dividends, many growth stocks won’t catch up with income stocks for 20 or 30 years.
One can always calculate the annual appreciation rate necessary to justify the purchase of any stock over the alternative investment offering the best after-tax return. But investment decisions between yield and growth stocks should be based, not merely on a stock’s appreciation rate, but on the spread between the appreciation rate and the company’s expected growth rate—on the rate of change, in other words, in P/E multiple.
Charts based on a 10-year holding period (the apparent average for individual investors) permit an investor to use his own assumptions about dividend growth rates and P/E multiple risk to gauge the relative appeal of growth and risk under differing tax rates. The charts are also handy for analyzing the effects of changes in discount and tax rates.