Wednesday, February 19, 2014

Types of dividend growth stocks

Throughout my experience as a dividend growth investor, I have identified three types of dividend growth stocks. Each type of equities comes with a distinct set of yield and growth characteristics, which the enterprising dividend investor can use to their advantage. In my dividend portfolio, I own all types of equities, in order to benefit from long-term growth and also to add some sustainable high income in case growth doesn't turn out as expected.

The three types include:

The first type includes high yielding stocks, which typically grow distributions more slowly. Most companies in this category include utilities, telecom, real estate investment trusts and many master limited partnerships. Many of these companies are natural monopolies over a certain activity such as electricity transmission in a particular area. There could be government regulation which ensures the monopoly status in a particular region, but also limits the amount of profits and returns on capital that companies could enjoy. Others, as in the case of REITs, have properties which are already established, and would take a lot of effort from competitors to replicate that success. After all, the chances of a competitor building a new mall next to an established one are very low, as it takes time to build something and might be impractical to engage in a price war to compete for customers when you have steep upfront costs to foot. These companies generate stable streams of earnings, which do not grow quickly, but are dependable. This results in fewer dividend cuts during recessions. Because of their slow growth, such companies typically yield more than the market. Examples of companies in the first type include:

Realty Income (O) has regularly raised distributions for 20 years in a row. The company has managed to increase dividends by 6%/year over the past decade.Yield: 5.30% (analysis)

Kinder Morgan Partners (KMP)  has regularly raised distributions for 18 years in a row. The partnership has managed to increase dividends by 7.40%/year over the past decade.Yield: 6.80% (analysis)

AT&T (T) has managed to increase dividend for 30 consecutive years. Over the past decade, the company has managed to boost dividends by 4.90%/year.Yield: 5% (analysis)

The second type includes companies in the sweet spot. These are dividend stalwarts, which generate strong earnings growth, and have average or above average yields. Some of these companies tend to satisfy everyday consumer needs for medicine, cosmetics, toiletries, food, gas etc. They tend to have strong brand names and wide moats which help these companies to charge a premium price to customers. The perceived qualities of these everyday products or services, make them a preferred choice for customers, who might be willing to go out of their way in order to find what they are looking for. For example, consumers would prefer Tylenol to its generic version. Others loyally purchase Gillette shaving products on a regular basis, without hesitation. These repeatable purchases, multiplied by millions of consumers worldwide, lead to a diversified stream of revenues for the companies that sell those produtcs. These companies also invest billions in research to identify new product or services solutions for their customers, identify efficiencies to increase profitability and expand organically or through acquisitions. Examples of the companies that will provide current yield with dividend growth include:

Coca-Cola (KO) has boosted distributions for 51 years in a row. The company has managed to increase dividends by 9.80%/year over the past decade.Yield: 3% (analysis)

Johnson & Johnson (JNJ) has regularly raised dividends for 51 years in a row. The company has managed to increase dividends by 10.80%/year over the past decade.Yield: 2.90% (analysis)

Wal-Mart Stores (WMT) has managed to increase dividend for 39 consecutive years. Over the past decade, the company has managed to boost dividends by 18%/year.Yield: 2.50% (analysis)

McDonald's (MCD) has boosted distributions for 38 years in a row. The company has managed to increase dividends by 22.80%/year over the past decade.Yield: 3.40% (analysis)

The third type of dividend growth stocks includes companies with strong earnings and dividend growth, which tend to have below average yields. These are the companies that are in a growth stage, and they tend to reinvest most of their earnings back into growing the business. Such companies have the potential to deliver high total returns over time, and the rapid dividend growth from a low base could deliver double or even triple digit yields on cost after a couple decades. Some of these stocks are typically richly priced, which is why the best time to purchase them is during market declines. Investors have to closely monitor these companies, in order to make sure that future growth can materialize. Otherwise, if growth slows down, shares that are trading at higher multiples could fall pretty quickly, even if earnings are still increasing. Some of the companies on my dividend growth wish list include:

Family Dollar (FDO) has boosted distributions for 38 years in a row. The company has managed to increase dividends by 13.60%/year over the past decade.Yield: 1.70% (analysis)

Casey's General Stores (CASY) has managed to increase dividend for 14 consecutive years. Over the past decade, the company has managed to boost dividends by 19.10%/year.Yield: 1.10% (analysis)

Yum! Brands (YUM) has boosted distributions for 10 years in a row. The company has managed to increase dividends by 15.10%/year over the past five years.Yield: 2% (analysis)

Full Disclosure: Long O, KMR, KO, JNJ, WMT, MCD, FDO, CASY, YUM

Relevant Articles:

Dividend yield or dividend growth?
Are High Dividend Stocks worth it?
The Sweet Spot of Dividend Investing
Seven wide-moat dividends stocks to consider
Five Things to Look For in a Real Estate Investment Trust


  1. Is DLR in the third category? Is DLR threatened by cloud computing? I like DLR business model.

  2. DLR has high yield and not that high growth. So it could be closer to 1st category..

    DLR does not seem to be threatened by cloud computing.

  3. Nice post.
    What charting tool do you use to display the key ratios (ROE, Dividend growth etc) in your analysis posts?
    Since you invest in MLPs - do you see filing taxes with the K-1 forms a hassle or worth it?

  4. Hi Sami,

    I don't see K-1 forms that big of a hassle for me.

    Most of the comments about MLP taxation being a hassle have seem to come from people who have never invested in MLPs, and are trying to scare others away. Of course, if you are uncomfortable with putting amounts from the tax statement into different tax forms, then it would not be for you. You are the one who should decide for yourself what is right for you. I only discuss what I do, which is not a recommendation for you to act upon.

  5. Two things...

    First, is there a fourth category of company. One that has started paying dividends within the last several years. My hypothesis would be that they would not start paying dividends without a long term plan to continue paying dividends. further, to attract dividend investors the annual increases would be substantial. i am thinking of AAPL as an example.

    Second, are tax preparing software such as TurboTax or TaxAct able to handle the K-1's for MLPs and REITs.

    How do you do your taxes? Paper and pencil, software, tax preparer?

  6. Hi SFS,

    Actually, there are mostly three types of companies based on yield/growth.

    However, based on stages of dividend growth, there are three types as well (this is what you are referring to):

    AAPL is a good example of a company in the initial stage. Whether it has what it takes to get to a dividend achiever only remains to be seen. I actually doubt AAPL will manage to increase distributions for a decade.

    As for your second question, turbotax, pen and pencil, and a paid tax preparer can each handle MLP taxes. I do my own taxes, but I am not representative for the readership, because of the complexity of my business affairs.

    Best Regards,


    1. I have used both TurboTax and H&R Block. Both have been able to handle the K-1's for me.

  7. You doubt Apple will manage to boost the dividend for over a decade? Strong words!:)
    I appreciate your perspective very much...I can only hope you are wrong as I own a position in Apple. 13/15 of my 12-13 year old students in my classes own Apple products in their homes and I see them as loyal Apple fans who will then continue to purchase Apple products as they get older.
    Why do you think Apple may not be able to boost dividends in a decade?
    Thanks for your continued blog posts and research!

  8. Hi Joe,

    Thank you for reading DGI site and commenting. I should probably write an article about this, but I would be very surprised if AAPL manages to maintain its high level of profitability, let alone increase EPS from here.

    In the world of tech, things move at a blazing fast speed. In 2007 there were no smartphones, and now in 2014 almost everyone in the world will have one. AAPL was first with iPod, iPhones and the Tablets, but its competitors are always one step behind it. What happens if AAPL does not bring to market another sexy and innovative product? Samsung and the Android system will eat Aapl's lunch. Plus, many of competing products are much better and cheaper than AAPLs. One factor that might be saving AAPL in the near term is the fact that it has long-term contracts with some Telecom companies, which specify a minimum number of purchase commitments for a certain period of time.

    I also don't think that there is a lot of product loyalty when it comes to technology. Remember the Motorola RAZR, the Blackberry, the Sony Walkman,

    The stock is "cheap" but if earnings per share fall by 50% by 2019 or say 2024, it would not be that cheap. For me to look at a DGI stock, I need to believe that EPS will increase over time. Otherwise, you can't have sustainable dividend growth.

    Of course, just because I don't believe EPS will grow, doesn't mean it won't grow. But I won't be putting my money there. Let's talk again in 5 years.

  9. Maybe a fourth type of category would be "possible future DG stocks in their infancy". These would be stocks that have recently initiated a dividend (within 5 years) and appear to be sending a message to the market that sustainability and growth of our dividend are paramount". Some examples would be AAPL, CSCO, AMGN, etc., where they have recently started paying a dividend, and have raised it AT LEAST 1-2 years in a row. The question is do they really have at least a narrow moat/ sustainable competitive advantages which will allow them to continue to grow earnings over the next 10-20 or even 30+ years, and also will they continue to reward shareholders with dividend increases every year. If one could identify those stocks and initiate a position, you may be getting on on the ground floor of a future dividend aristocrat. However the trick is identifying these stocks early enough to get in on the ground floor, and I also question whether technology stocks have the sustainable competitive advantages to turn into dividend aristocrats. I'm old enough (almost 56) to remember many of the "nifty fifty" stocks of the 70's, ones that were supposed to be "buy it and forget it" stocks. Many of the tech stocks flamed out- and are either gone or struggling in some remnant form- Kodak, Xerox, HP, etc. at on time they had growing dividends and it looked like the sky was the limit". Will APPL, CSCO, etc., be true DGI stocks? Only time will tell, as you say.


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