Why Does Dividend Growth Investing Work So Well?

Why Does Dividend Growth
Investing Work So Well?
By www.ProfitableInvestingTips.com

http://profitableinvestingtips.com/investing-trading/why-does-dividend-growth-investing-work-so-well
Among the more successful approaches
to long term investing, dividend
stocks provide a steady income
stream as well as the ability to reinvest
without paying fees.

When evaluating dividend stocks to
add to their portfolios, wise investors
look for a long history of continual
dividend payments and a steady
stream of dividend increases.

When you use this approach as your
guide, it is referred to as dividend
growth investing.

Why does dividend growth investing
work so well? Here are some thoughts
on the subject.

Why Does Dividend Growth
Investing Work So Well?

We have three simple answers to this
question.

They have to do with intrinsic stock
value, outperformance of the market as
a whole, and income protection in
times of overall market decline.

Intrinsic Stock Value of
Dividend Growth Stocks

First of all, steady dividend growth
over the years is a result of a company
making more money each year.

A steadily increasing income stream
indicates a strong intrinsic stock
value.

And a company with an intrinsic stock
value in excess of its market price is
always a good investment.

The market has a recurring tendency to
be overly greedy when times are good
and excessively fearful when times are
bad.

This fact can make the current market
price of a stock an inexact predictor of
underlying value in the coming years.

A company sells a product that
everyone needs and uses and has been
successfully making money with that
approach for decades or even more
than a century.

We refer to the likes of Coca Cola,
Exxon Mobile, Colgate Palmolive,
Procter & Gamble, and Eli Lilly and
Company.

These are investments with strong
intrinsic value as they will endure and
prosper over time.

The ability to steadily increase
dividends over the years and decades is
a sign of the intrinsic value of an
investment and a guide to successful
long term investing.

Market Performance
Characteristics of

Strong companies with high intrinsic
value not only may pay increasing
dividends over time but they tend to
increase their share prices as well.

Intelligent Income has a useful chart,
courtesy of Ned Davis Research, in
their article, 5 Reasons to Be a
Dividend Growth Investor.

While it may seem counterintuitive,
companies that consistently pay and
grow their dividends have historically
outperformed non-dividend stocks,
further increasing the appeal of being
a dividend growth investor.

[From the end of 1972 to the end of
1973,] companies that consistently
grew their dividends during this time
performed the best of any group and
delivered the lowest volatility
(standard deviation).

And, here is the chart showing that
over a longer time frame, dividend
growth investing provides the best
returns.

Performance of Dividend Growth Stocks

A 10% return on investment, with
dividends reinvested, will result in a
doubling of value every ten years.

This is a big part of why dividend
growth investing works so well.

Dividends as Asset
Protection in Down
Markets

While dividend growth stocks
outperform other dividend stocks and
stocks that do not pay dividends, they
also provide protection when the entire
market is down.

Intelligent Income again provides us
with a useful graph courtesy of
Hartford Funds.

This shows us how much dividend
income has contributed to total stock
market returns over the years.

Dividends As Part of Total Stock ROI

As we can see, steady and increasing
income from dividends provides a
significant return on investment over
the years.

When the stock market is languishing,
dividends can provide a majority of
returns, such as in the 1040s and
1970s.

And, in the first decade of this century,
when the market ended up lower than
when it started, dividends provided the
only income for someone who bought
in 2000 and sold before the market
recovered from the crash!

And, we know that while the percent
return of dividends is lower in years
with a surging stock market, we also
know that over time dividend growth
stocks tend to outperform the rest of
the market.

Criteria for Choosing

We found an interesting article
on Wallet Hacks about building
a dividend growth investment
portfolio.

It is a first person account of how the
author chose this approach and the
criteria he uses to pick investments in
this subset of stocks.

He mentioned that Warren Buffett
bought Coca Cola when it was low in
1988 and today gets a 45% dividend
based on his original investment!

Buffett acquired shares of Coca-Cola
in 1988.

Back then he wrote “We expect to hold
these securities for a long time.

In fact, when we own portions of
outstanding businesses with
outstanding managements, our
favorite holding period is forever.

We are just the opposite of those who
hurry to sell and book profits when
companies perform well but who
tenaciously hang on to businesses that
disappoint.

Peter Lynch aptly likens such behavior
to cutting the flowers and watering
the weeds.” (1998 letter)

The point of investing in companies
that steadily increase their dividends is
that you too can replicate Buffett’s
success.

An easy approach to investing in
dividend growth stocks is to pick a
fund that simply does the investing for
you.

The author mentions Vanguard
Dividend Appreciation Index Fund
Investor Shares (VDAIX) although
Fidelity and others offer similar
products.

The advantage is that you only need to
make one investment and not several.

And, you are getting a decent mix of
blue chip dividend stocks such as Coca-
Cola, P&G, Pepsi, Microsoft, J&J, Wal-
Mart, IBM, Medtronic, CVS, and 3M.

Alternatively, you can choose your own
stocks.

In this case, choosing companies that
have paid dividends for decades and
have been increasing them for a
quarter of a century or more is a good
place to start.

Then, to make sure that a great
company is not starting to fade from
the scene, look for “dividend coverage.”

This is earnings per share divided by
dividends per share.

A good coverage is 2 or more. In other
words, the company is paying out less
than half of its earnings in dividends
and is not simply jacking up the
dividend in order to disguise a failing
business!

And, when should you buy these
companies?

Because you are not trying to time the
market and are relying on long term
appreciation of stock price and
dividends, you can simply invest a set
amount every month, quarter, or year
as your cash flow allows, using intrinsic
stock value as a guide.

Why Does Dividend Growth Investing Work So Well?

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