I have been busy since early 2010 buying up equity stakes in companies that have lengthy dividend growth records. There is a methodology behind my madness, and I’ll explain.
You see, it would be easy for me to liquidate my six-figure portfolio and open my own business. Maybe I open a pizza shop and become a local hero, serving up pies to hungry patrons.
But would this be the best decision with my money?
Where do I think I will be able to make more money over the next 20 years: A collection of world-dominating, high-quality businesses like The Coca-Cola Company (KO), Johnson & Johnson (JNJ), and Chevron Corporation (CVX), or a local pizza shop? And that’s not to mention which choice would involve infinitely more hard work.
Before you sarcastically answer this rhetorical question, try and contemplate why the answer comes so easily and obviously to you.
See, there is no chicken or the egg syndrome here. Decades of dividend growth come on the back of being a high quality company, not the other way around. You don’t just pay out more and more cash, hoping that business just magically gets better and grows year after year. A business can pay out more and more dividends as a portion of profit because that profit is rising over time.
Now, back to my pizza shop example.
Let’s say I didn’t have a six-figure portfolio with which to bootstrap my little dream. Let’s instead assume I need capital. And let’s just say I have some investors that front me the cash necessary to fund Papa Jason’spizza shop, but require perpetual cash payments that rise every single year.
These are smart investors, after all, and don’t want to be told how great of a business this is and how their stake will surely be more valuable in time due to my managerial prowess in running a pizza shop; they want cold, hard cash in hand while they wait to see that equity investment rise in value. And they don’t want the same payment year in and year out. No, these are the really, really smart kind of investors, and they want more money every single year to keep up with (and hopefully exceed) inflation. These investors have lifestyles to maintain!
Think about that for a moment. It wouldn’t be enough for me to just be a local success story, selling enough pizza to pay all of my bills, fund a staff, allow myself a small salary to make my hard work worth it, and also pay out my investors. No, I have to pay my investors more cash ever single year. So that means more pizza, more chicken wings (I’ve expanded the menu by now), more toppings, more profit – year after year. It’s not enough to just be successful; I have to be more successful every single year in order to satisfy the growing payments to my hungry investors. While I’m selling pie to customers, my investors want a bigger slice of the profit pie, which has to grow in kind.
When you have a company grow its dividends for decades on end, that’s a result of a fantastic business model. You almost cannot grow dividends for 20 or 30 consecutive years and be a low-quality business; the two are pretty much mutually exclusive, assuming the dividend in question is still well-covered and poised to continue growing.
If I don’t run my pizza shop well and I’m unable to sell more and more pizza there is simply no possible way I can pay eager investors rising portions of my ever-growing profit pie. That’s because the profit base isn’tgrowing. Dividends are paid in cash, from cash. As such, there’s no way to “fake it”. Sure, I could take on debt to pay out my investors and this would work for a while. But over time, this scheme would blow up in my face when I can no longer afford both the rising debt payments and dividend payments. Something will eventually give, and that something will be my own little slice of Italy. Bye-bye Papa Jason’s!
When I look at Coca-Cola’s outstanding 52-year streak of rising dividend payouts, I think of the immense growth and consistency for a company to be able to do something like that. It requires a constant mind on the business, and the ability to maintain quality at all times. You can’t sell a crappy product and make more and more money for a century. It just doesn’t happen.
Focusing on companies that raise their dividends regularly and reliably forces me to hone in on businesses that tend to be rather high in quality. There are currently 519 companies on David Fish’s Champions, Contenders, and Challengers list – a document that tracks companies with at least five consecutive years of dividend growth, which is filters from the thousands of publicly traded stocks available to an investor. Furthermore, from those 519 companies with at least five years of growing dividends, only 105 companies have managed to raise their dividend payouts for at least 25 consecutive years. That’s 109 out of thousands. I’d say that’s a pretty special group!
While it doesn’t automatically mean that a company that chooses not to pay a dividend is somehow of lesser quality than a business that chooses to pay a dividend and/or raise that dividend payout regularly. However, a company that can manage to continue to raise its payout at rather impressive rates to investors after decades of already doing so is without a doubt doing something right. The cash doesn’t just appear out of thin air; the money that is paid out to investors year after year comes from constantly improving underlying business fundamentals. These are real businesses selling real products and/or services to real people. And the cash is real. And that real cash will one day pay for my real bills when I’m financially independent and living entirely off of my dividend income.
In the end, I focus on high-quality businesses that have competitive advantages which ensure that they can continue to pump out more dividends my way on the back of ever-growing profit. And the reason I do is simple: I like cash, but even more so I like more cash. And I’m doing my best as an investor to ensure that my passive income rises year in and out by focusing on the businesses that not only have a history of paying out more cash via dividends, but have an excellent chance at doing so for the foreseeable future.
Full Disclosure: Long KO, JNJ, CVX
How about you? Do you only buy companies that consistently pay and raise dividends? Why or why not?
Thanks for reading.
- High Yield Dividend Stocks in Gurus' Portfolio
- Top dividend stocks of Warren Buffett
- Top dividend stocks of George Soros