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5 Reasons Why Dividend Growth Investing Should Be Your New Year's Resolution

Dividend growth investing is an excellent New Year's resolution for the financially savvy

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Ben Reynolds
Dec 30, 2016
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(Published Dec. 29 by The Financial Canadian)

Everyone knows the age-old tradition of setting (and breaking) New Year’s Resolutions. There is evidence to suggest this tradition has existed for over 4,000 years.

Needless to say, making a resolution that will change and better your life is easy. Unfortunately, only 8% of people successfully carry out their New Year’s resolutions.

Why is it so hard for us to make changes in our lives? Well, the difficulty lies in the execution.

One of the greatest ways to keep your resolutions is to make them simple and measurable.
We will discuss how to make dividend growth investing your New Year’s resolution. Namely, it will focus on three things:

  1. Why Dividend Growth Investing?
  2. How to Quantify Your New Year’s Resolution
  3. A Step-by-Step Guide to Implementing Dividend Growth Investing

Why dividend growth investing?

We spend much of the holiday season purchasing gifts that depreciate in value over time. What if we purchased assets that increased in value over time instead?

Investors are much better off purchasing shares in high-quality dividend-paying companies and waiting for these companies to grow in value. This is particularly true when investors have a long time horizon.

“The single greatest edge an investor can have is a long-term orientation.” 

Seth Klarman (Trades, Portfolio)

 

Here I will provide five pieces of quantitative evidence to support dividend growth investing.

Reason one: The outperformance of the Dividend Aristocrats Index

The Dividend Aristocrats are a group of elite companies that are favorable for dividend growth investing. You can see all 50 Dividend Aristocrats here. To be included in the Dividend Aristocrats Index, a company must have the following characteristics:

  • Be in the S&P 500
  • Have 25-plus consecutive years of dividend increases
  • Meet certain minimum size and liquidity requirements

In order to raise annual dividend payments 25 consecutive times, one would expect the underlying business to be successful. Over the long run, this would be reflected in the stock prices and total returns.

02May2017141336.png?resize=710%2C986

Source: S&P Dividend Aristocrats Fact Sheet

This is indeed the case.

Over the past ten years, the Dividend Aristocrats Index has had an annualized total return of 9.79%, beating the S&P 500’s 6.89% by a solid margin.

Reason two: The outperformance of dividend growth stocks versus “no growth” dividend stocks

Dividend increases are indicative of underlying business success. Management would not raise dividend payments to shareholders if the business was not experiencing growth in revenues, profit and (most importantly) earnings per share.

As a result, one would expect businesses that consistently raise their dividends to outperform businesses that do not.

The data proves that this is indeed the case.

02May2017141338.png?resize=710%2C395

Source: Nuveen Asset Management

Over the long run (1972 to 2015), dividend growers have outperformed the three other categories (no growth dividend payers, non-dividend paying stocks and dividend cutters) while demonstrating less volatility.

This combination of higher return and lower volatility would lead to a much better risk-adjusted return (as measured by the Sharpe ratio).

Reason three: Dividend stocks versus non-dividend stocks

The following table presents the performance of stocks that pay no dividends (“non-payers”) against the five quintiles of dividend paying stocks.

02May2017141339.png?resize=710%2C404

Source: Dividends: A Review of Historical Returns

Over the very long term, each and every quintile of dividend-paying stocks have outperformed non-payers.

Further, the performance within the quintiles appears to be related to the yield of the stocks. The two best performing quintiles are also the two highest-yielding (quintiles 4 & 5).

Reason four: Long-term historical correlations

One method of determining new investment strategies is to consider long-term correlations. Examining which financial metrics move in tandem with stock prices can help to identify new sources of analysis.

The following table presents the long-term correlations (2000 to 2015) of various financial prices with total returns (dividends plus capital gains) for a sample of blue-chip Canadian companies.

02May2017141340.png?resize=710%2C229

Source: Publicly Available Financial Statements

Dividends exhibit the highest correlation (on average) with stock prices.

This means that dividend increases are the best predictor of total returns (at least in this sample).

Reason five: Lower probability of reducing dividends

As investors, some of the worst news we can hear is that of a dividend cut.

In an earlier Sure Dividend study, it was discovered that companies with at least 25 years of consecutive dividend increases (namely, the Dividend Aristocrats) had a significantly lower rate of cutting dividends than companies with shorter (10 to 24 years) histories of increasing dividends.

02May2017141340.png?resize=710%2C435

Source: Sure Dividend Study

By investing in companies with longer histories of increasing dividends, it appears we can reduce the risk of experiencing a dividend cut.

This provides added safety for dividend growth investors.

Quantifying your New Year’s resolution

Deciding to focus on dividend growth investing in 2017 is a commendable New Year’s resolution. However, it is important to refine this goal further.

Having an actionable New Year’s resolution is a key component of actually completing it. Below, I have included good and bad examples of a dividend growth New Year’s resolution.

The good example: “Each month in 2017, I will dedicate $1,000 for the purchase of a dividend growth stock.”

The bad example: “In 2017, I will invest in some dividend growth stocks if I have free cash.”

By quantifying your New Year’s resolution, it is much easier to measure your performance.

With the good example above, you either did achieve your goal (by purchasing $1,000 per month of dividend growth stocks) or you did not. The success measure is binary (yes or no), which helps simplify your investing.

Implementing dividend growth investing: A step-by-step guide

When it comes to actually building your dividend growth investing portfolio, there are a number of strategies you can use.

One approach is to invest exclusively in the Dividend Aristocrats – elite companies with at least 25 consecutive years of increasing dividends.

You can view the entire Dividend Aristocrats Index here. This link will provide you with an Excel document and allow you to sort by yield, sector and price-earnings ratio.

Alternatively, you could search even more exclusively and invest in the Dividend Kings. These are companies that have raised dividends for at least 50 consecutive years – twice as long as the Dividend Aristocrats.

A business must have an extremely strong competitive advantage in order to raise dividends for five consecutive decades. You can view the entire Dividend Kings Index here.

The overall goal of dividend growth investing is to invest in high-quality dividend-paying businesses trading at fair or better prices to build a stream of growing income.

Final thoughts

Dividend growth is nothing new. In fact, it has been written about since at least 1934, when "Security Analysis" by Benjamin Graham and David Dodd by was originally published.

“The prime purpose of a business corporation is to pay dividends regularly and, presumably, to increase the rate as time goes on.” – Benjamin Graham in "Security Analysis"

The evidence and outlined strategies presented for dividend growth investing will get 2017 started on the right foot and reward investors for years to come.

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