The most common style of investing the FIRE community recommends is index investing; it’s simple, low cost and easy. But there’s another style of investing that works well for a section of finance bloggers; Dividend Growth Investing (DGI).
I invited Tristan and Jasmin from Dividends Down Under to do a guest post on Dividend Growth Investing – Head over to their blog and check it out! – MR. AE
What is Dividend Growth Investing?
Dividend Growth Investing is simply buying individual stocks of companies that give growing dividends, even throughout recessions.
We’ve all heard of compounding – it’s one of the most boringly exciting things in the financial world. With DGI, the aim is to build a growing snowball of dividends until the income surpasses your desired expenses in retirement / financial independence.
If you choose your stocks wisely, your portfolio could pay you increasing dividends for the rest of life (faster than inflation) – your standard of living could increase as your retirement goes on.
Could you give a quick example of how that works?
For example you’ve built up your portfolio to be $1M in size and decided your desired annual expenses are $30,000 in retirement. If your $1M portfolio has an average yield of 3%, it’s going to pay you $30,000 in the first year. Great! That’s what you wanted. However, if your portfolio is full of DGI stocks that increase their dividends each year, you could (conservatively) expect a 4% increase overall each year. In the second year you’d get $31,200. In the third year you’d receive $32,448. This way, you never have to draw on your capital.
What are some typical DGI stocks?
(These are not recommendations, just examples of the type of companies that DGI bloggers buy).
Depending on what region of the world a blogger hails from, the potential DGI stocks differ in dividend history. As we’re DGI bloggers from Australia, I’ll give you two Australian examples: Ramsay Health Care (a private hospital operator) which has been growing its dividend consecutively since 1999. The other example is Invocare (a funeral and cemetery operator) which has been growing its dividend since 2005. If you owned these shares during the 2008 crash, and just focused on the dividends, you wouldn’t even know a crash happened.
Growing a dividend for 17 years straight is impressive, but North American companies have far more impressive records. There’s a list called the ‘Dividend Aristocrats’ that have been growing for at least 25 years. Some instantly recognizable names include:
- AT&T – increasing since 1985
- McDonalds – increasing since 1977
- Pepsico – increasing since 1973
- Target – increasing since 1968
- Walmart – increasing since 1975
There’s an even more prestigious list called the ‘Dividend Kings’ that have been growing for at least 50 years. These companies have been growing dividends before a lot of us were born! A few examples:
- Coca Cola – increasing since 1963
- Colgate Palmolive – increasing 1964
- Johnson & Johnson – increasing since 1963
- Proctor & Gamble – increasing since 1957
I am completely jealous of the companies North Americans can invest in. But, I’d stress that it’s important to not blindly start buying stocks. Have a look at what other people are doing and how they approach DGI investing.
What are some good DGI resources?
- Dividends Down Under – our site of course
Other than dividend growth, what are some other advantages?
Growing dividends for over 25 years would suggest the company has also been growing its profits for over 25 years – making them some of the most reliable companies in the world. A company has to be really good at what they do to grow that long.
Dividends are a more stable part of total returns, and are always positive. Receiving actual cash is much more ‘solid’ than a constantly changing share price. Dividends can give you that piece of mind.
Dividend aristocrats have been very successful at growing their share prices too, as successful as the S & P 500. Not only is the income increasing, your nest egg should hopefully increase too.
By investing in individual companies, you can take advantage of certain stocks if they’re ‘cheap’, but the rest of the market isn’t. The Wells Fargo recent banking scandal has hit their share price, so some DGI investors have used that as an opportunity to buy.
What are some of the things that DGI investors look at?
Good diversification is key. This means having many companies across a broad range of industries and geographies. For example, having a portfolio of just Pepsi and Coca Cola would be terrible diversification by industry – but at least their products are sold in (probably) every country in the world – which is good geographical diversification.
Profit/earnings growth – Companies that grow their earnings over the long term should keep paying out higher dividends and grow in value. Quality companies will usually have a strong brand and quality product – this allows them to increase their prices without any negative effect to their sales.
Sustainable growth – A company can only increase its dividend so much before its unsustainable. A good thing to look at is a company’s payout ratio (how much of its profits are paid out as a dividend). If a company has a 60% payout ratio, or less, it gives it more leeway to keep increasing the dividend if it has one bad year. It also means the company is re-investing more of its profits back into itself for future growth.
Business idea – The business idea behind the stock also has to make sense. Even if a stock has been growing its dividend for 25 years, it doesn’t mean it’s going to grow for another 25 years. You need to look at the big picture for each business too, not just the numbers. For example, cigarette and oil companies will probably find it difficult to keep building their profits over the long-term.
Buying price – No business is ‘buy at any price’, including dividend kings. If you overpay for your stocks then you could have paper losses for a long time. It’s up to you to decide what ‘overpaying’ is – perhaps you’ll only consider stocks with a dividend yield over 2.75%. There are many different ‘screeners’ that DGI investors use.
I’ve only just scratched the surface of dividend investing. I hope it was interesting and you can see why some people invest purely in DGI stocks. Being able to grow your dividend income, potentially for decades, is very appealing – which is why we follow this investment strategy too.
Readers – do you use the DGI strategy for your investing?
Some products that can help you:
Personal Capital: Personal Capital has a ton of great Free features, you can track your spending, net worth and even analyze your portfolio. It has top notch security and I am able to connect all of my accounts. Saves a ton of time!
Sofi – I saved a ton of money using SoFI for a Student Loan Refinance. They were great to work with, the process was super easy (compared to my previous refi) and I got a great rate. If you have student loans be sure to check them out.