Dividend growth investing explained
Dividend growth investing is an investment strategy with a focus on investors purchasing dividend paying companies that have a long history of increasing their dividend payments to shareholders.
As a share investor you take a considerable amount of risk by purchasing shares in individual companies. Recognise that, generally speaking, there are two types of investors.
So-called capital growth investors prefer to invest in shares that do not return any profits to shareholders. Rather they prefer companies that retain all their profits and reinvest those earnings back into the business in order to stimulate additional growth.
Capital growth investors assume that their company’s management will be doing their job, creating value with reinvested earnings instead of destroying it.
In comparison, as a dividend growth investor you minimise risk by selecting high quality dividend paying companies which not only maintain but also increase their dividends.
As a dedicated dividend growth investor your main goal is to generate an income stream, in particular one that is increasing above the rates of inflation.
In order to achieve that, you have to select high quality companies that could afford to pay an increasing dividend year after year. These companies will have sound business models which have withstood the test of many recessions.
Recessions affect almost all companies.
The message of the stock and bond market is that a second dip of the recession is likely, if we’re not already in one.
Recessions mean lower earnings and with dividends coming out of earnings – lower dividends. Be aware that companies can and do cut dividends.
Cut your risk of a cut in dividends with quality companies
Recessions also affect high quality dividend paying companies, but often not to the same degree that a non-paying dividend or a low quality dividend paying company is affected.
Usually a high quality company with a proven track record of paying dividends is a mature, entrenched, company with a solid business model as well as excellent competitive advantages in the marketplace
As a result of this stability in sales and earnings, these companies can afford to not only pay a stable dividend, but also share their prosperity with shareholders by consistently increasing the payments every year.
It is these qualities that lead to rising earnings which tend to support a steady pace of increase in dividends. In comparison, a company which does not have a solid business model typically cannot afford to raise dividends for more than a few years.
Companies with at least a decade long track record of regularly increasing their dividends provide tangible proof that they do have the cash-flows to pay them.
Also, companies that regularly increase their dividends often tend to be more careful with the way they allocate their financial resources. They know that cutting or eliminating the dividends to shareholders would result in lost confidence in company’s management as well as in a share price decline which could take years to recover from.
How to identify the right dividend paying companies?
Our investment research process is designed to throw out companies that are not attractive as soon as possible, thus enabling us to spend our limited time performing detailed research on potentially more interesting dividend income opportunities.
As an absolute minimum, consider:
- only companies that have a commitment to paying dividends and have done so for long periods of time
- only companies that have increased their dividends annually and have done so consistently
- companies that have a low payout ratio for those dividends, related to their earnings
- only companies that can sustain those dividends by having the earnings growth to continue paying them
- setting a target purchase price relative to dividend yield. Do not chase yields without identifying value
- only companies that have great fundamentals
- starting dividend growth investing as early as possible
- monitoring your holdings regularly to ensure there is no deterioration in the underlying fundamentals of the shares you hold
- building a well diversified core group of companies in your portfolio
- creating an income stream that will allow you to retire comfortably
As a dividend growth investor you are likely to accumulate a diversified portfolio of companies which have a long history of consistently growing dividends.
For retirement purposes, this method works best when you start as young as possible and invest on a regular basis, or when you start later with a large capital base.