Wednesday, July 8, 2015

Dividend Growth Investing – a great strategy for long term investors

I have been a dividend growth investor for over 7-8 years now. The reason why I have somewhere between 85% - 90% of my networth in dividend growth stocks is because of several factors. I have listed those factors below.

1) Dividend growth investing is a simple strategy that is easy to understand by almost everyone.

Essentially I allocate my capital into businesses that send me a portion of their growing profits every quarter. I can then use those dividend checks any way I want to, and they cannot be taken away from me. My investments are working for me around the globe, 24 hours a day, 7 days a week, 365 days an year, finding new ways to increase revenues, profits and dividends. In the case of a company like PepsiCo (PEP), it literally means selling hundreds of snacks and beverage products around the world to hungry and thirsty consumers. I view the dividends I receive from those companies as purely passive income, for which I did not have to work an insane amount of time each week for. The cash is stable and growing, and makes budgeting in retirement a breeze, since I won’t have to rely on complicated mathematical formulas that traditional asset depletion strategies require. The investments are those large blue chip companies whose products I use on a repeated basis, and whose business I understand. As these companies earn more over time, they reward me with dividend raises, which have always been in excess of my salary raises. It is as if my household has an extra worker, silently earning income for me, and sharing all of it with me.

2) The strategy is really cheap and easy to implement.

In order to start, one should look no further than the list of dividend champions and contenders that David Fish so graciously updates every single month. After that, the goal is to screen the list any time you have money to put to work. After narrowing the list of stocks per your entry criteria, you research each company and buy those that have higher chances of being around in 20 years and also have catalysts in place for future growth. Over time, you would be familiar with most of the dividend champions and dividend contenders, thus saving time in your process of building a diversified dividend portfolio. You can then monitor the progress of each company once an year or so, by checking and rechecking the story. If you essentially end up slowly building yourself a portfolio of the largest two or three dividend growth stocks from most sectors, you would be adequately diversified. Such as portfolio would have some small initial set-up costs in terms of brokerage commissions, but over time would be even cheaper than an index fund.

3) The strategy provides investors with a growing stream of cash flow each year.

In order to earn this growing stream of income, you do not need to show up for work five-six days a week and stay late in order to ship more TPS reports. You do not have to deal with unreasonable bosses, rude clients or coworkers, in order to earn dividend income. All you have to do is build a diversified portfolio of at least 30 – 40 quality businesses, and then monitor them regularly. You also do not have to play the corporate game in order to earn your dividend raise each year. The rate of dividend growth typically exceeds inflation, which ensures that the purchasing power of dividends is preserves. In the seven - eight years that I have done dividend growth investing, the rate of dividend increases has always exceeded the raises I get at my day job. My organic dividend growth has exceeded my target of 6%/year.

4) The strategy teaches investors to focus on businesses, and not get scared away by stock market fluctuations.

With dividend growth investing, you are always earning a positive return on your investment whether stock prices are going up or tanking down. This teaches you that dividends are a direct link between the underlying fundamentals of the business you are investing in, and your returns. Your long-term success in investments is ultimately determined based on the success of the business whose shares you purchased. Your goal is to find those businesses which you never want to sell, since they can shower you with more cash 10 – 20 - 30 years down the road. It is liberating to know that stock market fluctuations are there to serve you, and are not always an accurate measure of a company’s true worth. After all, if Colgate-Palmolive (CL) stock falls by 30% tomorrow because everyone is scared of stocks, that is a non-event for the patient holder (unless of course they want to put more money in Colgate). The real factors you should look for is whether Colgate manages to sell more toothpaste and dishwashing products over time. Meaningless short term price fluctuations, as well analyst opinions are just noise that needs to be ignored.

5) This strategy rewards patient investors, who have a long-term buy and hold mindset.

By continuously showering shareholders with a rising stream of dividend checks, those dividend paying companies are essentially turbo charging the compounding of income and principal. The real benefits of compounding are viewed after a 15 - 20 year period, when an investment in a company yielding 3% today can easily result in future yields on cost of 12% - 22%. This can be achieved by annual dividend growth of 10%/year, or through a combination of say 7% annual growth and dividend reinvestment in companies yielding 3% at the time of dividend cash availability. To put it in dollar terms, if you put $10,000 to work in 30 companies today at average yields of 3%, you would likely earn $9,000 in dividend income today. If you received and reinvested those growing dividends for 20 years, your annual dividend income would exceed $60,000/year.

6) The one thing that is really important is that everyone who wants to be in charge of their financial destiny can follow this simple strategy.

After all, the only person who truly cares about your success in investing is yourself and your close family. It is very motivating to invest money in stocks, and then receive dividends for decades on an investment you made years ago. With every investment, you are essentially buying future dividend income, which is akin to buying out your financial freedom one dividend stock at a time. If you earn $20/hour, any time you make a $2,000 purchase of a stock like Coca-Cola (KO), you essentially are purchasing 3 hours of freedom from having to work per year. It is not time consuming to scan the dividend champions and achievers lists, analyze companies, and then add those who have the potential for earnings growth to your diversified income portfolio.

7) The thing I really like about dividend growth investing is that it allows investors to sleep well at night.

If you have a diversified portfolio of at least 30 – 40 securities, built slowly at attractive valuations, that also produces enough income for you to live off of, you won’t care much about market volatility. This is because the diverse stream of dividends will provide cash flow to you when everyone’s returns are negative and they are losing their sleep. Even if a couple of your holdings cut or eliminate dividends, your total income should be fine if the remaining 38 companies boost distributions by an average of 5.26% that year. In addition, you will be able to squeeze out some income from the dividend cutters, if you replace them with other companies that are poised for further income growth. By focusing on income, and not total returns in retirement, you would not have to sell holdings when stock prices stay flat or go down. Not being at the mercy of the irrational Mr Market is one of the biggest advantages of dividend investing over traditional asset depletion approaches to retirement.

Full Disclosure: Long PEP,CL, KO,

Relevant Articles:

Investors Should Look for Organic Dividend Growth
Living off dividends in retirement
Four Percent Rule for Dividend Investing in Retirement
Dividend Growth Stocks – The best kept secret on Wall Street
How to retire in 10 years with dividend stocks

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