Published May 27th, 2015
Dividend growth investing is an investing style where one looks for businesses with a high likelihood of rewarding investors with rising dividend payments.
Realizing actual cash payments from your investments in the form of dividends ensures dividend growth investors will generate passive income from their investments.
There are many reasons to be a dividend growth investor.
Reason #1: Dividend Growth Stocks Have Beat The Market
This reason to be a dividend growth is the most attention-grabbing. Every investor wants to beat the market. Unfortunately, most don’t. Dividend growth stocks have outperformed the market – with lower volatility – from 1972 through 2014 as the image below shows.
Reason #2: Dividend Growth Investing Is Cost-Effective
Investing in mutual funds, managed accounts, and (to a lesser degree) ETF’s all costs investors money in the form of management fees. These management fees add up over time.
Buying individual stocks means you do not pay any management fees. Once the stock is purchased, there are no more costs associated with owning it. When I invest in something, I want it to pay me, not me pay for the privilege of holding the investment.
Reason #3: Dividend Growth Investing Focuses on Business
The underlying value of a stock comes from the value of a business. Over time, mediocre businesses fade out and are consumed by the creative destruction of competitive forces.
Excellent businesses compound investor wealth over time. Businesses with strong competitive advantages in slow changing industries have historically done well. Businesses like Coca-Cola (KO), AFLAC (AFL), Wal-Mart (WMT), and Johnson & Johnson (JNJ) all pay investors rising dividends each year and are in slow changing industries.
Discount brokerages and the deluge of financial media news can make buying stocks feel like playing the slots in Los Vegas. Nothing could be further from the truth. When you buy a stock, you buy fractional ownership of a business. Whether buying 100% of a business, 50%, or .00001%, it is important to focus on the aspects of the business, not the movement of the stock’s price.
Reason #4: Dividend Growth Investing Avoids Fads
When investors focus on building rising dividend income, they avoid fads. It is difficult to justify investing in the latest overvalued IPO when it doesn’t pay any dividends.
By focusing on stocks that pay dividends, investors avoid speculative businesses that do not generate cash flows. A business simply cannot pay dividends for long if it is losing money. This protects dividend growth investors from investing in speculative situations where cash flows are not being generated.
Dividend growth investors would not have invested in the absurdly overpriced stocks in the ‘dot com’ boom. These high flying internet companies were start-ups that typically did not pay dividends and had no history of profitability. This is the anathema of a dividend stock.
Similarly, dividend growth investors today avoid the overpriced fad stocks of today. Stocks like Twitter (TWTR), LinkedIn (LNKD), Facebook (FB), AliBaba (BABA), and Shake Shak (SHAK) all have price-to-sales ratios over 10 (!) along with no dividend payments. These are highly overpriced speculative stocks (not investments) that are very likely to underwhelm long-term shareholders.
Sometimes the best investments are the ones you don’t make. Investors sticking to dividend growth stocks will have an easier time avoiding the most overvalued speculative stocks on the market.
Reason #5: Dividend Growth Investing Is about The Long-Run
Dividend growth investing is a long-term prospect. Businesses that pay rising dividends year after year are best held for the long run. There is no point in rushing in and out of stocks if you are holding them for dividend payments.
Dividend growth stocks reward long-term investors by increasing dividend payments year-after-year. This slow-but-steady growth does not accrue to investors who are constantly switching stocks.
If you are focused on building long-term wealth by investing in great businesses, it makes little sense to jump from stock to stock. If PepsiCo was a high quality business a year ago, it will very likely be a high quality business another year (or decade) down the line.
Reason #6: Dividend Growth Investing Helps Weather Bear Markets
High quality dividend growth stocks have historically performed well during recessions. On an academic level, dividend growth stocks tend to have lower betas and lower stock price standard deviations. This means they tend to fall less during bear markets, but rise less during bull markets.
Fundamentally, high quality dividend growth stocks perform better than expected during recessions because they continue to produce solid earnings and dividends. Businesses that are able to maintain or grow earnings through recessions tend to see their stock prices perform better during recessions.
The maximum drawdown of the S&P 500 during the Great Recession of 2007 to 2009 was 55%. The maximum drawdown for several recession-resistant high quality dividend growth stocks during the Great Recession of 2007 to 2009 are listed below:
- McDonald’s (MCD): Maximum drawdown of 21%
- Wal-Mart (WMT): Maximum drawdown of 26%
- R. Bard (BCR): Maximum drawdown of 29%
- Abbott Laboratories (ABT): Maximum drawdown of 29%
McDonald’s and Wal-Mart are both known for their low priced goods. Wal-Mart has ‘everyday low prices’, while McDonald’s is known for its value menu. Both businesses grew through the Great Recession of 2007 to 2009 as consumers focused on saving money.
C.R. Bard and Abbott Laboratories are both health care businesses. The health care industry was less effected by the Great Recession than most other industries. It is very difficult for anyone to cut back on health care costs as they can translate directly into living longer.
Reason #7: Warren Buffett Is a Dividend Growth Investor
Warren Buffett is one of the richest people in the world. He has amassed a fortune of over $70 billion through savvy investing.
Warren Buffett’s investment style has changed throughout his career. Early in his career, he was primarily a value investor. Over time, Warren Buffett has gravitated toward high quality businesses that pay dividends. Warren Buffett’s 5 largest holdings all increase their dividends year-after-year. His top 5 holdings are listed below along with the percentage each makes of his total portfolio:
- Wells Fargo (WFC): 24% of portfolio
- Coca-Cola(KO): 15% of portfolio
- IBM (IBM): 11% of portfolio
- American Express (AXP): 11% of portfolio
- Wal-Mart (WMT): 5% of portfolio
Warren Buffett’s top 5 stocks make up 66% of his total portfolio. Wal-Mart and Coca-Cola have the longest dividend streaks of his top 5 holdings. Coca-Cola has increased its dividend payments for 53 consecutive years, while Wal-Mart has increased its dividend payments for 42 consecutive years.
It is true that Warren Buffett does not invest exclusively in dividend growth stocks. His biggest investments are in dividend growth stocks, however. Warren Buffett’s portfolio proves he is a dividend growth investor more than any other style of investing.
Reason #8: The Excellent Performance of the Dividend Aristocrats
The Dividend Aristocrats index is comprised exclusively of businesses with 25 or more consecutive years of dividend increases that are also in the S&P 500 and meet certain size and liquidity requirements.
The Dividend Aristocrats index as a whole has performed exceptionally well over the last decade. It should come as no surprise that businesses with strong competitive advantages and long histories of rising dividends tend to do better than mediocre businesses. The image below shows the outperformance of the Dividend Aristocrats Index over the last decade:
In total the Dividend Aristocrats Index has outperformed the S&P 500 by 2.47 percentage points each year over the last decade. Interestingly, the Dividend Aristocrats Index has outperformed the S&P 500 while having a standard deviation that is 93% of the S&P 500’s. The evidence that the Dividend Aristocrats have produced higher returns with lower risk corroborates the evidence in Reason #1 of this article that dividend growers and initiators have provided higher returns with lower risk.
Reason #9: Well Known Businesses
Many of the most well-known businesses are dividend growth stocks. Who hasn’t heard of Coca-Cola (KO), PepsiCo (PEP), Wal-Mart (WMT), Clorox (CLX), Procter & Gamble (PG), Johnson & Johnson (JNJ), or ExxonMobil (XOM)? All 7 of these stocks are Dividend Aristocrats.
Some investors might not recognize the name of some dividend growth stocks, but are very familiar with their products. For example: Kleenex, Huggies, Kotex, Pull-Ups, and Scott are all sold by consumer goods giant Kimberly-Clark (KMB). Are you familiar with Jack Daniels? That is sold by Brown-Forman (BF.B). Most people are also familiar with Ensure nutrition shakes and Similac baby formula. These brands are sold by Abbott Laboratories (ABT). Kimberly-Clark, Brown-Forman, and Abbott Laboratories are all Dividend Aristocrats as well.
There is a psychological advantage that comes with investing in businesses you know well. If the stock price of Kimberly-Clark dips during a recession you can take comfort in knowing the company’s brands are going to continue to be in demand. This means less panic selling and a greater propensity to hold for the long-run.
It is simply easier to understand the business model of a company whose products you are familiar. Coca-Cola’s business is very simple to understand. They sell soda, juice, water, tea, and other non-alcoholic drinks around the world. The familiarity one has with the company’s brands helps one better assess the company’s competitive advantage. There are less surprises when you understand how a business works.
Reason #10: Dividend Growth Investing Is Easy
At its core, dividend growth investing involves buying stock in high quality businesses with a history of raising dividend payments.
Looking for businesses with the ability to consistently increase dividend payments simplifies the investing process. Business that can raise dividend payments year after year very likely have a competitive advantage that protects profits. This significantly reduces the risk of a business declining versus investing in stocks that have unproven or unstable business models.
Aside from business risk, dividend growth investors also need to consider price risk. High quality dividend-paying stocks make for excellent long-term holdings. If the stock price is wildly overvalued, it will take years before the value of the business catches up with the stock price.
The Sure Dividend newsletter simplifies the process of dividend growth investing using The 8 Rules of Dividend Investing. The newsletter examines 160+ stocks with 25+ years of dividend payments without a reduction to find high quality dividend growth stocks trading at fair or better prices.
Reason #11: Dividend Growth Investing Is Fun
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in”
– John D. Rockefeller
Dividends should not be the only thing that gives one pleasure. John D. Rockefeller’s above quote does shed light onto the sense of satisfaction that comes with investing in dividend stocks.
There is something very rewarding about being notified of additional funds in your investment account – passive income simply from holding high quality dividend stocks.
Even more rewarding, these dividend payments grow over time. There are very few investments that offer both current income and future income growth. Dividend growth stocks provide current income now while growing your passive income stream well in excess of inflation (if done well).
Dividend growth investing combines high quality businesses with management’s who prioritize paying shareholders. The result is an easy-to-implement investing method that rewards investors with rising income streams. As a bonus, dividend growth investing has historically offered higher returns than the overall market with less volatility.