Dividend investing is either praised or condemned by investors. On one side, we have dividend growth investors religiously sticking to their plan and being for the most part successful. On the other side, we have those who opted for another strategy (mostly ETFs). ETF investors will tell you that you cannot beat the market and that a dollar paid by any corporation as a dividend is a dollar lost to the business. While I agree with the latter (dividends aren’t magic), I strongly disagree that one can’t systematically beat the market with dividend growth investing.
Dividend non-believers will be quick to remind you that dividend growth investing didn’t do so well during the 2020 crisis. While the V recovery is pretty much completed (keep in mind the market surely has some surprises for us before this is all over), major dividend growth ETFs are lagging behind.
When I look at my own performance since the beginning of the year, I get a similar result. I’m behind the market a bit. Then, why do I keep my dividend growers in my portfolio? Because this graph doesn’t tell the whole story. First, it only shows a 6-month period, while an investor’s life in the market is more like 50 years. Second, the S&P 500 performance is greatly supported by tech stocks (you’ve heard enough of them already). Once again, we must put in context why tech stocks are getting so much love these days. Third, building a retirement nest egg and living off your portfolio is not an overnight process. It is a lifelong goal.
In this article, I will review evidence on how dividend growth investing makes retirees happy as it generates more money in their pockets with less stress.
More money in your pockets
The first and probably the only reason why someone invests in the stock market is to make money. The idea is quite simple. You work hard, you save money, and you give that money to someone else (through buying company shares), so they can generate a fair return for your investment.
If you have your own business, chances are you started by letting your extra cash flow generate some more inside your company instead of taking it away. For those who are not entrepreneurs, the most convenient way to “get rich” is to invest in the stock market.
We all look at how we can make more money with our hard-earned money.
Data says dividend growth investing beats the market
If you google “dividend growth research”, you will find plenty of studies showing that dividend growers tend to perform very well. I’ve pulled out two graphs, so you don’t have to read dozens of pages to get to the same conclusion.
In this paper, Nuveen used well-respected Ned Davis Research data to show how dividend growers and initiators outperformed the market before and after a recession. If you want to look at the past 20 years, you can draw similar conclusions from a Vanguard’s case study!
You can also do more reading about how Dividend Kings (companies with more than 50 consecutive years of dividend increases) crushed the S&P 500 over the long run. You already know the song “past performance is no guarantee of future results”. It doesn’t mean that because something once worked that it will work in the future. But you can ask yourself this:
“Why do dividend growers seem to consistently outperform the market?”
Because dividend growers are exposed to factors of success
You can guess by now that I disagree with a very popular video Benjamin Felix published on YouTube last year entitled “The Irrelevance of Dividends“. In this video, he brings a strong point about the fact that dividends aren’t magic. A dividend paid by a corporation is a dollar taken from their bank account to be deposited in yours. Therefore, the company’s share value drops by the exact same amount. I totally agree with him on that indisputable fact.
He also mentions that, on average, dividend growers tend to do better than the market (I knew we would agree on something!). If you skip on the video to the 2:40 mark, he will tell you that’s not because of the dividends paid (that’s right), but because dividend growers have excess exposures to factors of success such as robust profitability, strong cash flow generation, and a proven business model.
So, here’s my point: isn’t that what you want as an investor? When I think of my portfolio, I want to pick companies that show such characteristics. I’m happy to discard the rest of the market and pick among the best fruits in the basket. This is a way of minimizing my risk of failing as an individual retail investor.
By selecting companies with a strong dividend triangle, I make sure I build a portfolio filled with market leaders generating predictable cash flow and surfing on strong growth vectors. When a recession hit, all companies have a hard time. Those with robust characteristics will survive and then thrive in the recovery.
Before becoming an online entrepreneur in the investing industry, I used to be a certified financial planner. Over a decade of working in this industry taught me a few things about investing and investors! I have come to realize that the largest source of an investor’s stock market loss isn’t from the market itself. It is from the investor’s panic in response to the market’s actions.
When the market is down (and it really doesn’t matter if it’s 5% or 50%), investors start to panic. They are concerned that “this is it” and that “this time is different”. They get convinced they are better off selling at a loss and returning to the market when things calm down. It sounds so cliché, but it is what happens every single time.
If you pick a strategy that reduces stress, you won’t be doing the high blood pressure number, and you may actually enjoy your retirement instead.
Data shows less volatility from dividend growers
Allow me to republish Vanguard’s graph and add focus on the blue bar:
As you can see, dividend growers not only produce better expected returns but they also do it with less volatility. The first obvious justification is dividends are still paid even if shares are down. Therefore, if your share value is down by 10%, but you cash a 4% dividend, you are only down by 6% in your portfolio. Non-dividend paying stocks can’t offer that to investors.
The second justification comes from what we just discussed about success factor exposures. If dividend growers usually show interesting growth perspectives and pristine balance sheets, chances are more investors will stick with them even during challenging times. Therefore, shares won’t be massively abandoned, and your portfolio won’t tank as fast as the market. You can even find extreme examples of companies that will post positive returns during the ugliest crashes.
Finally, it’s a quite simple strategy
You will notice that, throughout the entire article, I made sure to use the word “growth” between “dividend” and “investing”. That’s because it’s the most important concept. My entire investing strategy is based on companies that successfully increase their dividend consistently year after year.
While I obviously look at other metrics and consider qualitative analysis, my process remains relatively simple. Dividend growth is a product generated by a combination of various factors of success and financial metrics. You will rarely find dividend growers with lumpy revenue trends or mediocre margins. Management will not increase your paycheck if it’s not confident in the company’s ability to pay its dues going forward.
When you reduce the number of metrics and steps to analyze a company, you also reduce doubt and possible dilemmas. There is nothing more stressful than constantly wondering if you should buy more, hold your positions, or sell everything. A straightforward strategy such as dividend growth investments will not only help you build your retirement nest egg through your active working life, but it will also permit you to enjoy your retirement as you so richly deserve.
Many investors focus on dividend yield or dividend history. I respectfully think they’re making a mistake. While both metrics are important, aiming at companies that have and show the ability to continue raising their dividend by high single-digit to double-digit numbers will make your portfolio outperform others. When a company pushes its dividend so fast, it’s because it is also growing their revenues and earnings. Isn’t this the fundamental of investing – finding strong companies that will grow? If you are looking for a great combination of dividend and growth, check out Dividend Growth Rocks.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.