The Nuts And Bolts Of Dividend Growth Investing

By Sree (thetaoofwealth.wordpress.com)


This post contains the keys ideas to understand and carry out dividend growth investing.

 

1. Dividends are distributions by a corporation to its owners. Usually, what is distributed is money… cash. Occasionally, dividends are paid in shares rather than cash.

2. Many companies increase their dividends every year. These are “dividend growth” companies. They are the companies you want to own if you’re following a dividend growth strategy.Many dividend growth companies are well-known names, what many would call “blue chip” companies. Stock prices are not an indicator of whether a stock is a dividend growth stock. Whether a company is a dividend growth company is a function of corporate policy and practice, not the market.Dividends are discretionary.How much to pay (if anything), and whether to increase the amount from last time, are decided by the company’s management and board, not by the market.

3. The 5-year Rule simply says that a company must have raised its dividend for at least 5 consecutive years before I consider it as a dividend growth stock. A 5-year track record is certainly not the only evidence you might seek, but it is an important part.If a company does not have at least a 5-year streak of raising its dividends, I consider it ineligible for consideration as a dividend growth investment. I won’t buy it.I want companies that are clearly devoted to keeping their dividend growth streaks alive and have the financial strength to do so.The 5-Year Rule helps me identify them.

4. Compounding means earning money on money already earned. Compounding accelerates the rate at which dividends accumulate, like a snowball rolling down a hill.The term for compounding dividends is “dividend growth rate”(DGR).The dividend growth rate is independent from the dividend yield.A company with a low yield may have a high DGR, and vice-versa.

5. A constant annual percentage increase in a company’s dividends causes your dividend income to increase at a growing rate. This is called compounding. This snowball effect is the first layer of compounding in dividend growth investing.You can add a second layer of compounding that accelerates your dividend stream even faster.You do this by reinvesting the dividends.Your dividend income, which is growing anyway, grows even faster if you reinvest dividends.

6. Yield is one of the most common measurements in stock investing. Do you know what it is? Yield is the one-year percentage return on your investment from the dividend.The formula is Yield = 12 Months’ Dividends / Price.Yield on cost is kind of like yield, except that instead of using current price in the equation for yield, we use the original amount spent. Yield on Cost = 12 Months’ Dividends / Original Price.So as the dividend flow increases, the yield on cost goes up relentlessly.

7. The myth is that when the market does badly, dividends dry up. It just isn’t true.The fact is that dividends and the market are independent from each other.Total Return = Price Changes + Dividends. There are at least three “softening factors” that you get from dividend growth stocks: steady incoming cash, smoother ride through bear markets and faster recovery times. All of these softening factors help you to hold on to dividend growth stocks during times of market turbulence.

8. It is very realistic and possible to create a portfolio that will return, in dividends alone, the historic total return of the stock market, and to achieve this in 10 years or less.This goal is known as 10 by 10: That means generating a yield on cost of 10% within 10 years of when you start the portfolio.The 10 by 10 goal is achievable because of two factors: The initial yields on the stocks you buy, plus the dividend growth rates of those stocks. For example, a stock yielding 5% when you buy it will reach 10% yield on cost in 10 years if it increases its dividend 7% per year.You can get to the 10% yield goal even faster if you reinvest dividends.All of the above is true even if the current yield of your portfolio flat-lines, as it probably will (due to the increasing dollar value of your portfolio). The yield on cost will continue to march relentlessly higher as your companies raise their dividends, and as you reinvest them.

9. The reasons why you should be a dividend growth investor are:

• Dividends bypass the market.Corporate dividend policies rarely go haywire.
• Dividend investing can relieve obsession over market volatility. You partner with your businesses, sharing in its success over the long term.
• Dividends are real cash. It’s cash in your pocket.
• Dividend investing provides ongoing feedback about your investment. A dividend increase can normally be interpreted as a positive sign that management has confidence in the company’s prospects.
• The best dividend growth companies are outstanding businesses.It requires an outstanding business to increase dividends for many years in a row. Weak businesses simply cannot do it.
• Dividends increases continue even when stock prices decline.
• You do not have to sell the stock to get the dividend.
• Dividend payouts rise over time.This is the most powerful aspect of dividend growth stocks.
• Dividend stocks tend to be less volatile.Dividends have gentle trends that are fairly predictable.
• Your principal can grow too.Both dividend growth and price growth come from a common source: earnings growth.If the company is committed to annual dividend increases, they can make those happen even if they hit a bad patch for a year or two on the earnings front.So the dividend stock investor potentially gets positive returns from both sources of total return: dividends and price appreciation.
• Historically, dividend growth stocks have outperformed the market in total returns.
• You can reinvest dividends to accelerate the compounding effect.This builds wealth at an accelerating pace.
• Rising dividends protect against inflation.
• It requires no more money to acquire a portfolio of stocks that pays a dividend stream of 4% than to acquire a portfolio of stocks that must be sold piecemeal to generate the exact same 4%.This  is the amount often recommended to be “safe” to withdraw from a retirement portfolio.

10. When you are a dividend growth investor, you receive quarterly dividends from each company (monthly from some). If you are retired, you can take that rising cash stream as income and use it to pay your everyday expenses. What most dividend growth investors do if they don’t need all the cash is reinvest the dividends.There is no “right way” to reinvest dividends. You can allow the dividends to accumulate to a certain predetermined amount and then invest it in a stock you consider fairly valued or undervalued in a selective manner. This allows you to buy undervalued stocks and to buy any stock rather than the same stock.You compound your money by reinvesting the dividends to purchase more dividend growth shares.