By focusing on dividend growth, I am trying to pick the stocks, which have solid competitive advantages, whose revenues are relatively recession proof but could still grow earnings by innovation, acquisitions, and buybacks. Historical inflation rates have been around 3% for the US over the past one century. Thus, by focusing on companies, which have a long history of dividend increases of over 3%, I would create an inflation proof source of income.
In addition to that, if my stock picks raise dividends faster than the rate of inflation, I would be able to achieve very good yields on cost in the process. A company, which yields only 3% or 4%, might be scoffed at by yield chasing gurus, who wouldn’t even consider a stock unless it yields 8% or 10%. Those yield chasers might get the 10% yield now, but the cost of dividend cuts or no dividend increases makes chasing high yielding stocks a dangerous exercise with negative effects on wealth building.
At the same time a company that yields only 3% or 4% now, but grows its dividend payments at 12% annually, could generate a yield on cost of 6% to 8% in 6 years and yields on cost of 12% to 16% in 12 years. These companies exist in the market. It only takes an attentive dividend investor to uncover them. Examples of such companies are
Johnson & Johnson (NYSE:JNJ) has regularly hiked dividends for 47 years in a row. The ten-year average dividend growth for the producer of Neutrogena, Tylenol and Remicade is an impressive 13.30% annually. (analysis)
Procter & Gamble (NYSE:PG) has rewarded shareholders with dividend raises for 53 consecutive years. This consumer good juggernaut has managed to increase distributions at a rate of 10.70% annually over the past decade. (analysis)
Pepsi Co (NYSE:PEP) has increased its dividends for 37 consecutive years. The producer of Pepsi Cola, Mountain Dew, Lays and Doritos has delivered a 12.80% average dividend growth annually over the past decade. (analysis)
McDonald’ s (NYSE:MCD) has increased its dividends for 32 consecutive years. The worlds largest fast food chain has boosted dividends by an average of 27.30%/year over the past decade. (analysis)
I believe that even in 20 years people would still have a need to eat, drink, shower, shave and take pills. I would bet that even in 20 years people would still shop at McDonald’s – if not for their burgers then for the salads or whatever food sells the best.
Over time a portfolio of carefully selected dividend growth stocks could not only deliver a consistently increasing stream of dividend income which increases faster than inflation, but could also deliver outstanding total returns. Over the past fifteen, ten, five, three or one years, the dividend achievers index has outperformed the S&P 500. (source Mergent's)
The dividend achievers index consists of US stocks traded on NYSE, NASDAQ or AMEX, which have increased annual regular dividends for at least the past ten consecutive years. This index is a great shopping list for novice dividend investors. Even Peter Lynch, the famous manager of the Fidelity Magellan Fund, which outperformed the S&P 500 by a significant margin in the 1980’s, said : "The Dividend Achievers Handbook is one of my favorite bedside thrillers. Here's a simple way to succeed in Wall Street: Buy the stocks on Mergent's list and stick with them as long as they stay on the list"
As a dividend growth investor my primary objective is growth in dividend income without losing too much of my capital in the process. Capital appreciation is second of importance. I believe that if my portfolio generates enough dividend income for me, I would not have to rely on selling 4% of my portfolio at depressed prices in order to live off my investments.
Full disclosure: Long MCD, JNJ, PG and PEP
Dividend Growth Investor
- High Yield Dividend Stocks in Gurus' Portfolio
- Top dividend stocks of Warren Buffett
- Top dividend stocks of George Soros