Wednesday, June 19, 2013

How to crush the market with dividend growth investing

Dividend growth investing is the true underdog of investment strategies. It is not because the strategy fails to generate consistent returns to investors, but because it is not lucrative for the financial industry. It is also misunderstood because it focuses on dividends that grow, not simply yield. Dividend growth investing is a simple investing strategy that focuses on buying and holding quality companies at attractive valuations, which have the potential to increase earnings and dividends along the way. This is do-it-yourself type investing that relies on long-term holding and involves minimal transaction or advisory fees.

What could be simpler that selecting companies with a proven track record of increasing dividends, trading at attractive valuations, that also exhibit the potential for future earnings growth? As long as you monitor your positions, you can essentially set it and forget it and ignore the day to day noise of Wall Street. What critics of dividend growth investing fail to see is that a growing enterprise that consistently earns more, and pays more in dividends is more valuable over time. Thus, dividend growth investors can have their cake ( the dividend stock) while eating it too (receiving growing streams of dividend income).

I have several exhibits, which discuss performance of dividend growth investing over different time frames. The first exhibit below is from an independent study of returns of S&P 500 Index stocks by dividend policy, prepared by Ned Davis Research. The study shows that a $100 investment in dividend growers and initiators in 1972 turned into a cool $4,168 by the end of 2012, compared to $1,622 for an investment in S&P 500. However, the investors that put $100 in 1972 in non-dividend payers and dividend cutters & eliminators ended up with only $193 and $88 after 41 years! This chart shows you that dividend investing provides you with an edge.

The second chart shows the performance of Dividend Champions between 2007 and 2012:

This is my performance since 2007: I achieved this not because I have a magic ball, but because I have a strategy that provides me with an edge against everyone else. As a dividend growth investor, I could care less how I do relative to the market however. Performance relative to a benchmark is not an actionable item, but something that could provide confusion and make otherwise smart investors question their strategy at the worst time possible. Switching strategies at the wrong times because you lack confidence is a sure way to never amass any wealth in the stock market.

Two other investors performance that I am attaching is the one from fellow blogger Dividends4Life through March 31, 2013:

In my investing, all I care about is selecting great companies at attractive valuations, strong competitive advantages, a track record of raising dividends and the potential for earnings increases. The market can fluctuate all it wants, but by ignoring it and focusing on what matters I have been able to crush it since 2008. After all, companies like Coca-Cola (KO) and Chevron (CVX) will satisfy consumer demands for several decades to come. These companies with enduring competitive advantages are much more likely to pump out billions more in profits and afford to pay higher distributions.

Dividend growth investing is not going to outperform the market every single year, but over time it should deliver a performance that should at the very least slightly exceed S&P 500 results. No investment strategy in the world will generate consistent profits all the time, and outperform its benchmark all the time. Investors should have confidence in their approach, and not let temporary underperformance make them switch strategies. The only sure way to lose money in the stock market is to search for a strategy that makes profits all the time, and thus switching strategies often.

By focusing on quality, dividend growth investors uncover value and outperform indices over time, despite not caring about general stock market fluctuations. This is a winning strategy that can not only deliver a growing stream of dividends to live off, but also grow investors income over time.

Another reason why dividend growth investing is perfect for retired investors is because it protects from the variability of year to year returns. The problem with living off of index funds is that you risk having to sell a chunk of your portfolio when stock prices are unreasonably depressed. An index could go up by 10%/year every year on average, but this could mean going down by 50% in year one and being flat in year two. This could cause you to sell at the bottom in order to fund your living expenses, which could leave fewer dollars left to capture any upside in stock prices. It could also leave less dollars to fund your retirement. The growing dividend yield on the other hand provides a baseline that supports the living expenses of the retiree. When everyone else realizes falling stock prices could cause them to go back to work, the dividend growth retiree would care less as they will be drowning in cash from their portfolios. Not surprisingly, the rising dividends  would also provide an income stream that maintains purchasing power against inflation.

Full Disclosure: Long KO and CVX

Relevant Articles:

Check Out the complete Archive of Articles
Dividend Growth Investing Gets No Respect
Buy and Hold means Buy and Monitor
The Dividend Edge
Are performance comparisons to S&P 500 necessary for dividend investors


  1. Hi

    I have become a fan of your blog and have learned a ton reading and researching! Thanks for doing this!

    Question: Do you still think ( or do you) investing in a typical 401K plan with say Vanguard is a good idea or do you place everything you got into your diversified dividend portfolio? I am currently maxing out my 401K and using additional income to fund my dividend portfolio (sparingly). I have been thinking about starting to back off the 401K a little and invest more in my dividend portfolio. Thoughts?

    Thanks again

  2. "Switching strategies at the wrong times because you lack confidence is a sure way to never amass any wealth in the stock market."

    That quote should be in a book.

  3. Hi Tom,

    This year, I decided to max out 401K and IRA plans, simply to save on taxes. If you were single, making more than $33,650, you are in the 25% marginal tax rate. That means every dollar you put in there, you are better off.

    Now I am also maxing out 401K. Which kinda leaves me with less money to buy dividend stocks every month. But honestly, I think I am better off having a higher base in a 401K, than a lower base in taxable account. Also, when I switch jobs, I would be able to roll it over into an IRA, where I can buy individual stocks.

    But yeah, any additional income is put directly into dividend stocks.


    Thank you very much for the kind words. I had an argument with someone, who informed me that I should switch strategies when I underperform relative to the S&P 500. This was the dumbest idea that I had ever heard - although it inspired the sentence you quoted ;-)

  4. how do you monitor those dividend cut/freeze/increase? where do set up alerts for these news?

  5. Hi JJ,

    You can set up a portfolio list in Yahoo! Finance for stocks you are interested in,or own, and then scan headlines. It takes little time.

    If you have say 40 - 50 stocks, it should not be an issue.

    Another way is to subscribe to news releases of companies you are interested in by email..

  6. Investing in stock is not a rocket science, having said that it isn’t a cakewalk either. Thanks for the educational post, was looking for something like this. Inspires me to trade my stocks better.

  7. In the Ned Davis research, why is the total return of the S&P 500 not included? He is using only the price change to get to $1696. If he had included reinvested dividends (in other words, the actual total growth of the index), he would have found that $100 grew to $4983, which would have been the best strategy of them all. That seems to be an important piece of information to leave out, as you would have been better off simply throwing money into the index and setting it on auto-pilot with dividends reinvesting than trying to individually pick the best dividend payers.

  8. Matt,

    Thank you for stopping by and thinking outside the box.

    The NDR study shows total returns. It compares "S&P 500 Geometric Equal-Weighted Total Return", to equal-weighted returns for the various buckets within S&P 500, based on dividend policy.

    Thus, you are comparing capitalization weighted S&P 500 returns to equal weighted S&P 500 returns. It is interesting however that the cap weighted S&P 500 has outperformed an equally based one over the past 40 years.

    I am curious how dividend stocks performed in a capitalization weighted approach, versus equal weighted.

    1. Dividend Growth Investor, google and you will see Ned Davis Research re-constituted the components of each index each month. He did this with the S&P 500 along with the other indices. This means to replicate the results above, one has to be willing to trade a helluva lot, disregarding short term capital gain taxes for one. I suppose Ned and his people will claim they wanted an apples-to-apples comparison. This is fine, but then it also means we are not comparing buy-hold-and-auto-reinvest dividends approaches. From a practical standpoint, I think Ned Davis Research's studies on this point are worthless to Jane and Joe Investor. The sole value this research has is to help brokers turn people against buying an S&P 500 index fund. If one googles, those using this research are overwhelmingly brokers who want their clients to trade in individual stocks, so as to line the wallets of said brokers. Don't get me wrong: I am a dividend growth investor. But I have also long been aware that total return wise, and for long terms, the S&P 500 is thoroughly competitive with a dividend growth portfolio.

  9. IMO it's way too broad a statement to say..."but because it is not lucrative for the financial industry". Sure stock brokers wouldn't like a low/no-trade policy because they get less commissions. But they don't make up the entire field of professional investors...why would I, as an investment manager who gets paid on the value of assets (and not trades) not like this strategy? As a matter of fact I do like this strategy and use it for a significant portion of each portfolio I manage.

  10. Anon,

    Unfortunately, you are more of the exception rather than the rule.

    Thanks for reading DGI site!


  11. If you have a lump sum,is it reasonable to wait for better valuations in the market to begin your dividend reinvestment program? For example, if you have $1 million to invest in a diversified portfolio wouldn't it be better to wait for a better S&P dividend before committing? The p/e of the s&p is greater than average. If I wait for a correction, I'll have better income, as I'm close to retirement, within five years.

  12. Since the S&P 500 has a higher than average price-to-earnings ratio, wouldn't it be better to invest a lump sum when valuations are more in line with an average market? Since I am close to retirement, should I wait to invest a lump sum in a diversified portfolio? What is important to me in five years, when I retire, is income, not market value. I expect a significant correction when Fed changes policy - sometime in the next two years. I could have a yield of 4% instead of 3% or $40,000 vs $30,000 on a $1,000,000 portfolio.


Questions or comments? You can reach out to me at my website address name at gmail dot com.

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