The Philosophy of Dividend Aristocrat Stocks

dividend aristocrat - The Philosophy of Dividend Aristocrat Stocks

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One popular form of dividend investing involves a group of stocks called dividend aristocrats. Standards of what makes up a dividend aristocrat vary. However, most analysts define it by three criteria. One, they must belong to the S&P 500 index. Two, they meet specific size and liquidity metrics. Three, and most importantly, they must have increased their dividend for 25 or more consecutive years.

Such a status remains exclusive. Of the thousands of stocks that trade on American exchanges, only 53 stocks currently hold dividend aristocrat status. To understand how a dividend aristocrat functions, one must understand its traits.

Stability Drives Investors to Buy Dividend Aristocrat Stocks

Dividend aristocrats have some distinct benefits. Only the most stable stocks fall into the dividend aristocrat category. Both earning and holding this status requires both long-term growth and stable profits.

Many investors would describe these stocks as “boring.” The typical dividend aristocrat will trade at a price-earnings (PE) ratio in the teens. Most will see revenue and earnings growth in the low-single-digits. Such stocks rarely make the news.

One such stock is industrial company Dover Corp (NYSE:DOV). It’s possible that many investors who follow the likes of, Inc. (NASDAQ:AMZN) or Tesla Inc (NASDAQ:TSLA) have never heard of Dover. Yet, despite its low profile, Dover holds the record for the longest line of dividend increases. It has raised its dividend each of the last 62 years.

Some better-known companies also hold a dividend aristocrat status. Procter & Gamble Co (NYSE:PG) holds the second-longest streak at 61 years. Johnson & Johnson (NYSE:JNJ) stock has also seen 55 straight years of increases. Both have been seen as low-growth but prudently managed companies for decades.

Dividend Aristocrat Status Also Pressures Companies

However, such a status does not come without some burden on the company. The streak of rising dividends places a lot of pressure on these firms to maintain the annual hikes. From the company’s point of view, the dividend aristocrat label serves as both a blessing and a curse.

The label engenders a feeling of stability and trust, pushing investors to buy and hold. However, this trust comes with the underlying threat of massive selloffs should their streak end. These stocks sometimes forfeit their status, especially during financial crises. Still, companies will avoid breaking the streak if they can.

Investors can benefit from such a scenario. AT&T Inc. (NYSE:T) serves as one example. Today, AT&T finds itself in the wireless service business. With few companies competing in this area and the high barriers to entry, success for AT&T is almost assured.

However, competition has driven profit margins to low levels. Moreover, the need to upgrade to 5G technology compels AT&T to spend tens of billions of dollars to hold its market share in this business.

AT&T must also spend to maintain its streak of dividend increases. Recent declines in the T stock price have pushed the dividend yield above 6%, more than three times the S&P 500 average. Regardless of the high yield, keeping the annual dividend increases will likely prove less costly than losing its dividend aristocrat status. Hence, investors should expect dividend increases to continue despite the high yield.

Many Other Stocks Seek Dividend Aristocrat Status

Investors should also look for possible future dividend aristocrats. For example, IBM (NYSE:IBM) has paid a dividend every quarter since 1916. However, the company ran into trouble in 1993 that forced it to slash the dividend. The company stabilized itself and began annual dividend increases in the late-1990s. If it maintains this streak, IBM will become a dividend aristocrat in the next few years.

Also, dividend aristocrat philosophy might be catching on with relatively younger firms. Cisco Systems, Inc. (NASDAQ:CSCO) scoffed at the idea of paying dividends in the 1990s. However, with the end of the tech boom and years of stagnation after, attitudes changed. Today, Cisco not only pays a dividend, it also has increased quarterly payouts every year since 2011. It has since become a stable, slow-growth business that rarely makes it into the headlines. While CSCO stock may or may not gain dividend aristocrat status years from now, the company’s behavior shows the influence of these stocks.

The Standard for Stable, Long-Term Growth

Investors who understand the traits of a dividend aristocrat can earn high, long-term returns in these equities. These stocks have served as the standard for stable, long-term growth for decades. Over time, the value of the stock depends heavily on maintaining the streak of dividend increases. Hence, only challenges that threaten the survival of a company will dissuade these firms from forfeiting the dividend aristocrat status.

To be sure, stock market investments, regardless of diversification, require some level of risk. Individual stocks typically carry more risk. However, stable, slow-growth and the pressure to maintain a streak of dividend increases should motivate even the most risk-averse investors to buy a dividend aristocrat.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.

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