Retirement Strategy: What Does Dividend Growth Investing Actually Mean?

Regarded Solutions

There are so many different roads that an investor can use to become financially secure that, even if I actually knew them all, it would take days to list them all! I do know that there are a handful of approaches that most people choose, so I will just list them:

  • Stock picking based on the fundamentals of a company, or the technicals that many day traders use
  • Momentum trading, which means to me when a stock is on a hot streak, investors hop on for the ride
  • Day trading, which means never investing in a stock, but picking one that fits a particular trend and buying and selling within each day.
  • Following the herd investing, which to me means it happens to be a popular stock, or an IPO, or a strong sector; tends to be trend investing, not for the long term
  • Contrarian trading, which to me is going against conventional wisdom and buying stocks for large rebounds and short-term gains

I left off dividend growth investing because that is the approach I am focusing on. So I will go into more detail, in my own simple way, for folks to understand how I define it.

Dividend Growth Investing

The popularity of this long-term buy-and-hold strategy has lots of traders calling it a “cult,” and in some ways it might be! I know I wouldn’t invest any other way, and I have tried them all over the last 50 years. So I am part of the “cult.”

I believe it has been so popular for decades now due to the fact that for investors who know what they want, and focus on the rewards, the strategy has actually been shown to work.

Here is a simple definition from this website:

They are a lot of stocks on the market that are paying returns to their shareholders, called dividends. A dividend is distribution of money decided by the directors of a company, and this distribution can happen quarterly, semi-annually, annually, and sometimes even monthly … and can be paid from company earnings but also from available cash on the company accounts. 

I think that is a pretty simple explanation, but let me expand:

Some of these dividend-paying companies also have been raising their dividends over time, sometimes for years and years, and these are the stocks that I myself have focused on. Over a period of 25 to 50 consecutive years or more, these companies, through good times and bad, have never missed a payment and have increased the dividend each and every year.

Those companies are called Dividend Aristocrats and Dividend Kings. These companies tend to be quite large, have been in business for many years and have navigated all economic environments successfully, and keep paying shareholders a dividend even as the company has matured and could not be considered a “growth” stock any longer. Yes, these companies usually grow their revenues and earnings somewhat, but there are times, sometimes long periods of time, that a business has either become more difficult, has new competition, has weak management, or has made costly mistakes that impact the revenues and earnings which might, and has led to losses for a period of time. However, these particular companies find ways to continue paying and increasing its dividend every single year. Here is a chart I borrowed from an old article of mine that shows just Dividend Kings versus the S&P 500: 

See the source image

Folks who are solid divided growth investors are willing to hold these stocks for decades, and the primary focus is the income that the dividends produce. As a matter of fact, I personally know people whose only focus is growing their income stream no matter what the stock is doing in any particular period of time.

The growth of the income stream is what will create financial security over time and could lead to either an early retirement, or a very nice lifestyle from the passive dividend income alone. It is a long, boring process and even the companies are boring. Not to DGI’ers of course, but to the rest of the investing population that seek to make as much money as possible in the shortest amount of time through capital appreciation, and these folks couldn’t care less about a dividend. 

Unfortunately, most of these types of investors wind up either losing in financial distress or quitting investing, screaming that the markets are rigged. This article pretty much sums up the facts:

90% of traders fail or only 10% are really successful … Probably, typically in your life as well you’ve probably done or have been through multiple activities and it’s a process that’s a process that you jump from one thing to the next to the next until you finally find something that works for you for a longer period of time … Now if we connect this concept of hopping from one thing to the next into trading, people typically do the same thing when it comes to trading they will jump into trading stocks then they may jump into trading options without really being really good at trading stocks they will get into options then from options they may trade Forex because they weren’t really good about that or they want to try something new. …

That’s not their specialty, and that’s not their expertise, but this is what happens in the stock market – people give it a try! They hop in and out they try something else, and then eventually they don’t do it anymore. If you add all those people up then of course you’re going to see that 90% fail just like 90% of new small business owners fail as well. 

How Dividend Investing Works

Let’s keep this simple. A dividend growth investor selects the following stocks to invest in, right now (I am using 1,000 shares for this example but the math is the same if I were to use 1 share of each stock, just different income amounts):

  1. Altria (MO– 1,000 shares @ $39.53/share and the annual dividend is currently $3,440.
  2. Coca-Cola (KO– 1,000 shares @ $50.03/share and the annual dividend is currently $1,640.
  3. Johnson & Johnson (JNJ– 1,000 shares @ $148.10/share and the annual dividend is currently $4,040.
  4. Procter & Gamble (PG– 1,000 shares @ $144.39/share and the annual dividend is currently $3,160.
  5. Colgate-Palmolive (CL– 1,000 shares @ $80.31/share and the annual dividend is currently $1,760.

The one thing that these stocks have in common is that they are Dividend Kings and have an average of about 55 consecutive years of dividend growth

No, I do not advocate starting with just five stocks, by the way. I was never able to deal with much more than 20. Perhaps 10 stocks might be a decent starting point for many folks just starting out.

The annual dividend paid the shareholders with these 5,000 shares is $14,040. The last five-year growth rate of these five stocks is roughly 5.65%. That means in the last five years, shareholders have gotten a raise of about 5.65% each year on average, just by holding the shares.

If the dividends were reinvested, which younger dividend growth investors should do, the number of total shares would be significantly more, and the annual income stream would be much higher – without adding one more share with cash!

The point is that the share price at any given time does not matter for anything other than buying or selling the stocks. Since we are not selling (unless something negative happens with the dividend), the price matters only when we buy it. For argument’s sake, let’s simply assume these prices are fairly valued. If the share price drops by 25%, or increases by 25%, a true dividend growth investor will basically ignore it. It is all about the income stream and its growth, not the share price. 

If the average share price drops by 25%, it might look ugly on paper, but if the dividend growth stays the same, we are doing our job, and growing our income. I am not saying that total return does not count, but the focus is on the income stream. A loss is never incurred, nor is a gain reaped, until, or unless, we sell the shares.

What I Look At To Evaluate A Stock

Well, here is my own personal list:

  • Is it a Dividend King or Aristocrat?
  • What is the last five-year dividend growth rate average?
  • The payout ratio
  • The current cash flow, cash on hand and the balance sheet
  • Is it enough to cover the dividends and pay the debts?
  • What is its current dividend yield?
  • Are there any major problems that could impact the income stream?
  • The quarterly conference call and what management has to say publicly

Notice I didn’t say anything about the share price, its latest earnings report, or current business conditions. If a stock can continue to pay and increase the dividend, that is all I care about.

An income stream is real money and can be reinvested or used to pay expenses. A share price, if a stock is never sold, means very little to me – aside from being nice to look at!

Yes, there are times when a stock is sold. This is my list of reasons:

  1. The dividend gets cut drastically.
  2. The dividend is eliminated.
  3. The balance sheet becomes a major liability, meaning the financials are too weak to continue paying the dividend.
  4. A change in my personal circumstance that forces me to liquidate (which is what happened to me)

There are other dividend growth investors may sell shares for other reasons, like switching from one stock to another, or deciding to invest in an “opportunity” high-yield stock that carries more risk. To me, right now, that might mean Exxon Mobil (XOM) or a mortgage REIT like Annaly Capital (NLY).

I have used this approach myself in order to tweak the income stream and accept the added risks with small positions. With XOM the risks are vastly different from those of NLY, by the way.

The most important approach towards dividend growth investing are really simple:

  • It’s all about the income.
  • Know your risk tolerance and why you are investing.
  • Do your due diligence and research on a regular basis.
  • Focus on increasing the income stream, basically all the time.
  • Time in the market is vastly more important than timing the market. 

My Bottom Line

I know there are other nuances that may tweak the strategy, and many DGI’ers would argue that stocks other than Aristocrats and Kings be part of a portfolio. That is perfectly fine, but as long as the income keeps rolling in and continues to grow, the portfolio value is secondary. 

So many recent newcomers like to argue that if the share price goes down, it negates the dividend. It is my opinion, and that of most DGI’ers, that the argument is nothing more than a strawman by those folks who are not dividend growth investors – folks who might not fully understand what this approach to investing actually is.

I am not saying that DGI is the only and the best way to invest. There are numerous ways and the choice is simply up to you.Not To Bore You, But…

Knowledge is power, and many folks shy away from the investing world because that very world makes it more confusing each and every day in an effort to sell you something.

My work here will remain free to all of my followers (unless it is an Editor’s Pick! Then, the article will be openly available for only 24 hours or so.But I have no Marketplace service). My hope is that I’ll give you some of the things that took years for me to learn myself.

One final note: The only favor I ask is that you click the “Follow” button and become a real-time follower to receive emails that my articles have been published, and so I can grow my Seeking Alpha friendships. That is my personal blessing in doing this and how I can offer my experiences to as many regular folks as possible who might not otherwise receive it.

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.

Additional disclosure: Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author used in his past worked for him, and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.