An Introduction to Dividend Growth Investing
What is Dividend Growth Investing
The term “dividend growth investing” (DGI) has taken on many different meanings. This term is used by several hundred funds and ETFs, all of which vary in their approach. Among the practitioners of this strategy, the amount of variation in how stocks are selected is truly astounding. Therefore, given its wide usage, one can’t assume any particular strategy is referenced whenever the term is used.
At the most abstract level, DGI is primarily used as an income strategy. This way of investing buys the stocks of companies that not only pay dividends, but raise their dividends every year. The idea of having your payouts grow makes DGI one of the most popular strategies for investing.
DGI is one of the easiest strategies to implement, and at the same time, one of the most difficult strategies to carry out. It is easy since almost all large companies pay a dividend, and among these, a majority raise their dividends every year.
The difficult part is to pick just those companies that will raise their dividends the most year after year. The “dividend” part of DGI is easy, but the “growth” part is hard.
When one reads analytical reviews of income strategies, market commentaries, fund marketing material, or even reviews by other practitioners of dividend growth investing, there is never any clarity about the exact nature of the portfolios, how companies are chosen nor any data about how the portfolios are performing.
Our practice of DGI involves selecting about two dozen diversified, growing, successful global companies where the primary objective is 8%-10% growth of dividend income compounded over long time frames.
If you’d like to learn more about our DGI strategy specifically, check out our model portfolio.
Popular Examples of DGI
There are many different lists of companies that pay dividends. Some lists contain companies that have raised their dividends for more than 10 years or 20 years. There are lists of companies whose payout growths are the highest over the last five years. There are lists of dividend payers in Canada, or in Asia, or in Europe, etc.
Mutual fund companies have created individual dividend funds based on these lists, slicing and dicing them up in various ways. All such funds sell themselves as dividend growth funds, and there are several hundreds to choose from. However, the payout growth for most of these funds is about 6%, and their growth is trending downward over the last few years.
Another popular category of dividend growth investing is individual utility stocks and funds that are made up of such utility stocks. These funds are fairly steady in their income growth at about 2% to 21⁄2%. Also popular among investors are telecom stocks and funds, which have about the same steady returns and growth in payouts as the utilities.
Another easy way to practice DGI is to purchase a subscription to one of many dividend newsletters, or find an advisor who practices DGI for his/her clients. This was our favorite technique until the actual income growth of these portfolios was discovered to be too low (about 5% – 6% per year).
Of course, anyone can try their hand at picking just the right companies. This is a very low cost approach to DGI, but the time and effort needed to become good at picking the right companies is beyond the interest and capability of the average of investor.
Reinvestment and Income Growth
In some cases, investors will reinvest the dividends being received back into the portfolio. This is referred to as dividend reinvestment, which usually means that any dividend received is automatically reinvested in more shares of the company which issued the dividend.
This is very easy to do as most brokers and/or custodians will provide this as a free service for any account and most any customer. We do not engage in this type of dividend reinvestment. Instead, dividends are accumulated until there is about $1,000.00 in the account. Then this cash is used either to initiate a new stock position, or to add to an existing position.
The $1,000.00 minimum is used so that the commission per share, as a percentage of the price, is minimized. The use of dividend payments to reinvest into the portfolio adds about 1% per year to the compounded rate of income growth. Thus, if the rate of income growth that is due to dividend growth is, for example, 8%, then it will be at least 9% or more with reinvestment, and this effect compounds over the years. But it gets even better…
Other Income Sources in Equity Portfolios
There are several other sources of income other than dividend income. This “other income” is due mostly to two phenomena that occur in equity portfolios. The first is corporate reorganizations, and the second is regular portfolio transactions.
Over the long term, large, growing companies in a dividend growth portfolio will engage in some type of corporate reorganization. This can result in the company getting rid of a division, selling a particular brand, spinning off part of the company into another tradable company, and a host of other types of reorganizations.
These activities can result in special payments, or ownership in companies that do not fit into the portfolio and are subsequently sold by the investor. These reorganization events can lead to significant income and this income can also be reinvested in the portfolio to create an additional boost to income growth in the future.
Another source of income, other than dividends, will occur when sales occur because a company is being sold from the portfolio. In general, sales such as these should result in capital losses and capital gains that more or less equal out.
However, because companies are held over long time frames and markets rise over the same time frames, portfolio sales result in additional income that can be reinvested. In a rising market, this “other income” can be substantial, even if there are only one or two such transactions per year.
For the author’s investments, these two sources of income have generated so much income that the income growth rate has doubled to more than 20% per year.
20% income growth per year shouldn’t be expected every year. This level of income growth is highly correlated to bull markets. However, a participant in DGI as practiced by the author should expect 20% income per year when averaged over the long term.
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