Dividend growth investors typically focus on a minimum record of dividend increases which is anywhere between 5 and 25 years. The purpose of focusing on companies with an established record of consistent dividend raises is to identify corporate boards which are eager and willing to reward shareholders with higher distributions. I also believe that a long streak of dividend increases is one of the indicators of a business with strong underlying fundamentals. Regular dividend increases which are supported by gradual increases in profits over time are essential for providing retirees with an inflation adjusted stream of income during their non-working years, which does not rely on reinvestment.
In my investing I have often focused on years of consecutive dividend increases as well. After analyzing many companies over the past six years on my blog, I have come to the conclusion that the optimum number of consecutive years of dividend increases is ten. An average economic cycle, peak to trough, lasts for approximately five years on average. The requirement to have at least a decade of consecutive dividend increases is important, because this amount of time typically covers approximately two economic cycles.
I selected this amount in order to avoid selecting companies which simply got lucky of being in the right place at the right time. If you were a commodities producer between 2000 and 2008, you could have easily afforded to raise dividends per share, since earnings were buyout by record commodities prices. Examples include Rio Tinto (RTP) and Nucor (NUE). Unfortunately, Rio Tinto cut distributions in 2009, while Nucor stopped paying special dividends in 2008, and has grown regular distributions at a measly rate of less than 1%/year since then.
In addition, companies which raise dividends for less than 10 years could have afforded to so because of new dividend growth stock syndrome. When companies start paying dividends for the first time they pay a small initial amount and have a low payout ratio. As a result these companies can afford to raise dividends at a double digit rate for a long period of time. As their dividend payout ratios increase however, and if their earnings are flat, these companies will find it increasingly difficult to not only maintain same rate of dividend increases but even to boost distributions. Future dividend growth would likely be limited by earnings growth, which is the important relationship that dividend growth investing very heavily relies on. Waste Management (WM) is a prime example of a company in the new dividend growth stock syndrome. Since initiating a dividend in 2004, Waste Management has almost doubled it to 35.50 cents/share from 18.80 cents in 2004. However, the dividend payout ratio has expanded from 46% in 2004 to 67%, based on estimated earnings for 2013 of $2.19/share.
I also focus on dividend kings, which includes companies that have raised dividends for over 50 years. I mostly focus on this list in order to study each company, and learn more about the factors that enabled them to achieve this record. Diebold (DBD) is the company with the longest record of annual dividend increases with 60 years. That doesn't automatically make it a buy however, which I determined when I last analyzed the company.
In summary, I am looking for that perfect dividend growth stock which grows earnings per share and dividends at a similar rate and yields at least 2.50% today. At some point, it is more important to focus on dividend growth and entry criteria, than years of consecutive dividend increases. That is why I have found ten to be the optimum number in my investing. This company would usually yield similar amounts over time, even as earnings and dividends increase. Capital appreciation comes very handy however, as it protects purchasing power against principal and rewards patient long term dividend investors. It is an equally essential component to total returns, as are dividends.
Full Disclosure: Long NUE
- Complete List of Articles on Dividend Growth Investor website
- A long streak of dividend growth is an indication of a business with exceptional fundamentals
- The predictive value of rising dividends
- The Dividend Kings List for 2014
- How to buy when there is blood on the streets
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