About Dividend Growth Investing​

Basic Concept of Dividend Growth Investing


Dividend growth investing (DGI) is a strategy whose goal is to build a sufficient, reliable, growing stream of income from stocks.


DGI is not the opposite of “growth” or “total return” investing. Nor is it contradictory to those styles.


Rather, DGI is simply an approach that emphasizes income over growth. Growth will come to the DGI investor. DG stocks are not stagnant businesses. They grow, and the investor will benefit from that growth too. The difference is that some of the investor’s return will be sent to him or her on a continual basis in the form of dividends.


You achieve these dual goals – attractive income and long-term growth – by buying and accumulating shares of excellent companies that have records of raising their dividends every year.


Not all investors are aware that there are scores of companies with long annual streaks of increasing their dividends. Some of those companies have been raising their dividends for more than 50 years – undeterred by wars, bear markets, and recessions.


Since 1950, dividends have provided about 30% of the stock market’s total return. This chart shows dividends’ contributions since the 1950s by decade. The average across all seven decades is shown to the far right.

The numbers above do not assume that the investor reinvested the dividends. But many DG investors accelerate the growth of income and share counts by reinvesting the dividends that they receive.


Reinvesting triggers compounding, which means that the additional shares purchased with prior dividends generate their own future dividends, so the total dividend payout increases. It’s a cycle that repeats every time dividends are invested back into the portfolio.


Total return increases too. The following graph shows that the total return of the S&P 500 with dividends reinvested since 2000 has been just about double the return without dividends reinvested.

[Source: ETF Replay showing results for SPY, an ETF that tracks the S&P 500]

Thus DGI creates a self-funding cash machine, even if you’re not adding new outside money to your portfolio.

The Three Keys to DGI Success


I strongly believe in Benjamin Graham’s concept that the individual investor runs his or her own business, which he called an “investment operation.”


"An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."


DGI can be the business model of an investment operation. There are three keys to making this work.


The first key is to identify the best DG companies. These excellent companies not only pay dividends, but also:

  • Are financially solid, well-run, high-quality companies.
  • Have great businesses with sustainable competitive advantages.
  • Raise their dividends each year.

Key number two is to obtain shares at good prices. You shop for stocks that have a fair price or are on sale. You never overpay, although you will be willing to pay “full price” for true excellence.


The final key is to manage your portfolio intelligently. This means not only selecting great DG stocks at favorable prices, but also applying sound portfolio management principles to advantageously add, trim, sell, or replace stocks.

Dividend growth investing is not a get-rich-quick scheme. Rather, it is a methodical, long-term strategy that any investor can execute. With DGI, you collect the stocks of great companies and share in their successes. You don’t trade their stocks like baseball cards.

Who Uses DGI?


I have learned over the years that “dividend growth investing” has many meanings and uses.


Some investors use it primarily to build an income stream that they will use in retirement. That’s how I got started. The idea is that by the time you retire, your income will be not only sufficient for your needs, but it will also keep your retirement income ahead of inflation for the many years that you are in retirement.


Some investors use DGI to build wealth. Long-term studies, such as the one shown below, show that rising-dividend stocks have produced better total returns than the broad stock market. Building wealth and building income are not contradictory goals.

And, of course, there are many investors who strive for goals that lie between pure-income and pure-wealth pursuits. “Growth and income” is a time-honored investment goal, and DGI is perfectly suited to it.


Why Use DGI?


I have used DGI almost exclusively since 2008. Its main impact on my investing life was to change my focus from ever-changing prices to more-stable dividends.


That paradigm shift helped me become a much better stock investor. It made me less reactive to everyday market ups and downs, slowed down my trading, and led me to think more about the long term.


Thinking about long-term business results instead of short-term price changes all but forces you to think about the quality of companies that you invest in. You want to collect stock in the best companies. It takes an especially high-quality business to be able to raise its dividend every year for decades. Weak companies simply cannot do it.


Focusing on dividends has another benefit: It draws your attention away from price swings in the market. A company’s dividend payments are independent from its stock price.


This 15-year graph of Johnson & Johnson’s price and dividends illustrates dividend stability vs. price volatility.

J&J has had its price ups and downs over the past 15 years, but its dividend has gone only in one direction: Up. That’s the kind of stock that most DG investors want.


So your attention shift from prices to dividends is helpful, because it makes you less likely to trade based on price action. J&J’s blue price line in the graph above has many drops that might have triggered a panicky response in an investor. The orange dividend line has none. It’s better to focus on the orange line.


How Much Can You Expect to Earn?


It does not get much publicity, but the number of dollars distributed as dividends each year is enormous. It’s in the same order of magnitude as the huge, multi-billion-dollar government programs that have been created to help the country through the coronavirus crisis.


Stocks in the S&P 500 paid out $485.4 billion to shareholders in 2019. That’s a new record, rising for the 8th straight year.


And anybody can get in on it. You don’t have to apply anywhere. You simply have to buy and own the stocks to collect the dividends.


There is a loose relationship between the size of dividends and their speed of growth. Not many companies can provide both large dividends and fast dividend growth for any significant length of time.


Therefore, the DG investor often needs to choose whether he or she is more interested in high dividends with modest growth, or lower dividends that grow very fast.


Or you can do what I do, which is to diversify among types. I own high yielders, slow growers, low yielders, and fast growers, as well as all mid-range categories in between.


I would say that, with a well-rounded portfolio, you can expect, in most years across the whole portfolio:

  • 5%-8% income growth per year if you don’t reinvest dividends
  • 7%-12% if you reinvest the dividends, accounting for the fact that reinvestment provides a 2%-4% kicker to the dividend growth rate each year

Of course, if you build a portfolio that explicitly targets high yields or fast dividend growth, your results will skew toward those targets.


DGI in Your Working Years


It is often said that income-focused investing is only suitable for retirees or those approaching retirement, and that younger folks should aim for maximum price growth before switching to an income focus.


I won’t take either side in what can become an almost-religious debate. I will simply say that over long time periods, DG stocks with dividends reinvested have produced competitive total returns compared to the general market. While the DG investor is focused on optimizing income, he or she simultaneously builds a portfolio that produces similar total results to the general market.


DGI When You Are Nearing or in Retirement


People require income — personal cashflow — to pay for the necessities and luxuries of life. Capital tied up in stocks (or any investment) must be converted to cash to be of any use.


The unique thing about dividend growth stocks is that they provide cash flow organically: Dividends are declared by the companies themselves, and they are sent to you directly by each company.


Dividends don’t flow through the market, and they are not affected by the market. The market has nothing to do with dividends. They come from a different mechanism altogether: Companies send them straight to their shareholders.


Therefore, you don’t need to sell assets to receive your cash.The dividends come to you without any action needed on your part.


If you reach a point that you can live on the organic income from your investments (when added to other income such as pension or Social Security benefits), you will achieve financial independence. You won't need to sell your assets for spending money, so your assets will never run out. Inflation won’t bring you down, because studies show that in most years, the rising dividends grow faster than inflation.


Many professional advisers refer to the retirement years as a “decumulation” phase. That means that they portray retirement as requiring a sell-off of assets to provide the income you need. The main question becomes, at what rate can you liquidate your assets without running out of assets to sell while you are still alive?


Most DG investors don’t look at retirement that way. Their assets – DG stocks – send them money, and the amount increases each year. Under normal circumstances, such retirees don’t have to sell anything to fund their retirements.


Some people say, “A dollar is a dollar, why do you care where it comes from?” But the difference is important. The difference is that if you are selling shares to fund retirement, you are depleting your assets. Conversely, the retiree who simply collects dividends is not depleting his or her assets.


A common analogy to DG investing is the case of a landlord. There is an obvious difference between a landlord who slowly sells off his or her rental properties compared to a landlord who collects the rents and does not sell their properties. The first landlord will eventually run out of properties to sell. The second will not.


One will often hear that living off income is only for the very wealthy. That misses the fact that you don’t need to be any wealthier to build a portfolio that pays you than a portfolio that does not. The only difference is what kind of stocks you own.

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