Dividend growth 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% per 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