Published December 29th, 2016 by The Financial Canadian
Everyone knows the age old tradition of setting (and breaking) New Year’s Resolutions. There is evidence to suggest that this tradition has existed for over 4,000 years.
Needless to say, making a resolution that will change and better your life is easy. Unfortunately, only 8% of people successfully carry out their New Year’s resolutions.
Why is it so hard for us to make changes in our lives? Well, the difficulty lies in the execution.
One of the greatest ways is to keep your resolutions is to make them simple and measurable.
This article will discuss how to make dividend growth investing your New Year’s resolution. Namely, it will focus on three things:
- Why Dividend Growth Investing?
- How to Quantify Your New Year’s Resolution
- A Step-by-Step Guide to Implementing Dividend Growth Investing
Why Dividend Growth Investing?
We spend much of the holiday season purchasing gifts that depreciate in value over time. What if we purchased assets that increased in value over time instead?
Investors are much better off purchasing shares in high-quality dividend-paying companies, and waiting for these companies to grow in value. This is particularly true when investors have a long time horizon.
“The single greatest edge an investor can have is a long-term orientation.”
– Seth Klarman
Here I will provide five pieces of quantitative evidence to support dividend growth investing.
Reason One: The Outperformance of the Dividend Aristocrats Index
The Dividend Aristocrats are a group of elite companies that are favorable for dividend growth investing. You can see all 50 Dividend Aristocrats here. To be included in the Dividend Aristocrats Index, a company must have the following characteristics:
- Be in the S&P 500
- Have 25+ consecutive years of dividend increases
- Meet certain minimum size & liquidity requirements
In order to raise annual dividend payments 25 consecutive times, one would expect the underlying business to be successful. Over the long run, this would be reflected in the stock prices and total returns.
This is indeed the case.
Over the past ten years, the Dividend Aristocrats Index has had an annualized total return of 9.79%, beating the S&P 500’s 6.89% by a solid margin.
Reason Two: The Outperformance of Dividend Growth Stocks Versus “No Growth” Dividend Stocks
Dividend increases are indicative of underlying business success. Management would not raise dividend payments to shareholders if the business was not experiencing growth in revenues, profit, and (most importantly) earnings per share.
As a result, one would expect that businesses that consistently raise their dividends to outperform businesses that don’t.
The data proves that this is indeed the case.
Source: Nuveen Asset Management
Over the long run (1972-2015) dividend growers have outperformed the three other categories (no-growth dividend payers, non-dividend paying stocks, and dividend cutters) while demonstrating less volatility.
This combination of higher return and lower volatility would lead to a much better risk-adjusted return (as measured by the Sharpe ratio).
Reason Three: Dividend Stocks Versus Non Dividend Stocks
The following table presents the performance of stocks that pay no dividends (“non-payers”) against the five quintiles of dividend paying stocks.
Over the very long term, each and every quintile of dividend-paying stocks have outperformed non-payers.
Further, the performance within the quintiles appears to be related to the yield of the stocks. The two best performing quintiles are also the two highest yielding (quintiles 4 & 5).
Reason Four: Long-Term Historical Correlations
One method of determining new investment strategies is to consider long-term correlations. Examining which financial metrics move in tandem with stock prices can help to identify new sources of analysis.
The following table presents the long-term (2000-2015) correlations of various financial prices with total returns (dividends + capital gains) for a sample of blue-chip Canadian companies.
Source: Publicly Available Financial Statements
Dividends exhibit the highest correlation (on average) with stock prices.
This means that dividend increases are the best predictor of total returns (at least in this sample).
Reason Five: Lower Probability of Reducing Dividends
As investors, some of the worst news we can hear is that of a dividend cut.
In an earlier Sure Dividend study, it was discovered that companies with 25+ years of consecutive dividend increases (namely, the Dividend Aristocrats) had a significantly lower rate of cutting dividends than companies with shorter (10-24 year) histories of increasing dividends.
Source: Sure Dividend Study
By investing in companies with longer histories of increasing dividends, it appears we can reduce the risk of experiencing a dividend cut.
This provides added safety for dividend growth investors.
Quantifying Your New Year’s Resolution
Deciding to focus on dividend growth investing in 2017 is a commendable New Year’s resolution. However, it is important to refine this goal further.
Having an actionable New Year’s resolution is a key component of actually completing it. Below, I’ve included good and bad examples of a dividend growth New Year’s resolution.
The Good Example: “Each month in 2017, I will dedicate $1000 for the purchase of a dividend growth stock.”
The Bad Example: “In 2017, I will invest in some dividend growth stocks if I have free cash.”
By quantifying your New Year’s resolution, it is much easier to measure your performance.
With the good example above, you either did achieve your goal (by purchasing $1k/month of dividend growth stocks) or you did not. The success measure is binary (yes/no), which helps simplify your investing.
Implementing Dividend Growth Investing: A Step-By-Step Guide
When it comes to actually building your dividend growth investing portfolio, there are a number of strategies you can use.
One approach is to invest exclusively in the Dividend Aristocrats – elite companies with 25+ consecutive years of increasing dividends.
You can view the entire Dividend Aristocrats Index here. This link will provide you with an Excel document and allow you to sort by yield, sector, and P/E ratio.
Alternatively, you could search even more exclusively and invest in the Dividend Kings. These are companies that have raised dividends for 50+ consecutive years – twice as long as the Dividend Aristocrats.
A business must have an extremely strong competitive advantage in order to raise dividends for five consecutive decades. You can view the entire Dividend Kings Index here.
The overall goal of dividend growth investing is to invest in high quality dividend paying businesses trading at fair or better prices to build a stream of growing income.
Dividend growth is nothing new. In fact, it has been written about since at least 1934, when Security Analysis (a famous book on investing) was originally published.
“The prime purpose of a business corporation is to pay dividends regularly and, presumably, to increase the rate as time goes on.”
– Benjamin Graham in Security Analysis
Dividend growth investing will get 2017 started on the right foot and reward investors for years to come. This post has presented evidence and outlined strategies to implement dividend growth investing in the year to come.