The gems of the stock market - dividend growth stocks

The gems of the stock market – dividend growth stocks

The gems of the stock market – dividend growth stocks

OCTOBER 7, 2017     AUTHOR: SHAUN

Want to earn balanced returns, beat inflation and like the “set it and forget it” mentality. Don’t overlook dividend growth stocks.


The stock market can appear quite intimidating. Not only is it portrayed as cut-throat and fast-paced, but with so much investing noise, it’s difficult to know where to begin. It’s a real shame that so many would-be successful investors sit on the sidelines or play it “safe.”

“Safe” investors feel like they need to invest but do so almost too cautiously.  They restrict themselves to products that are only guaranteed – like GICs or bonds.  Their skepticism causes them only to earn 1-2% a year – barely the rate of inflation!  And that’s even before they pay taxes on it!

You should strive to ensure your hard-earned money maintains its value. Historically, that would mean you would need to earn 2-3% after tax to beat inflation. That small nuance of “after tax” actually makes a BIG difference.

Add it all up, and most people should strive for 5%+ return to pay the tax-man and beat inflation adequately.

That begs this question then. How do you get there?  What’s a sound investment to reach 5%, but still avoid lots of risk?

One of the best types of investments to help get you there are dividend growth stocks. I feel it’s a must-have in every long-term investor’s portfolio (including those new to investing). They’re great products because they reward you as if you’re an owner, provide balanced returns, and enforce a “set it and forget it” type mentality.

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You get paid as if you’re an owner

First off, when you buy stock, you buy a piece of ownership in a company. Based on this, you would assume that you make money the way most owners do – through a piece of the profits. Strangely enough, that’s not the case will all stocks.

Let me break it down for you…

Stocks earn you money in two ways:

(1) Shares are worth more over time, and the price of each share goes up, and;

(2) Investors get a piece of the profits through dividends.

There’s a good pool of stocks that only focus on the former. Instead of returning profits to shareholders, they plow them back into the business to help grow the company. They never pay their shareholders a dividend.  This is helpful to the enterprise, but not always useful to you, the owner.

Think about it… would you be OK starting a business and locking away your money, only to make your first dollar 5-10 years from now when you sell? If you could guarantee me $1M, maybe. But nothing’s ever guaranteed.

I prefer the second option – where the stocks give you a piece of the profits. Paying me a regular dividend helps me feel like I’m being rewarded for my investment. It also helps me hold on to that stock for a long time.  Since I know another paycheck is around the corner, I’m less reluctant to sell. 
 

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You can get paid really well

Research from Manulife and Ned Davis Research (2014) show that dividend stocks perform better in the long-run.

How much better?  Personally, I was surprised…

When you compare all S&P 500 stocks (mainly the biggest 500 stocks in the US) over the past 40 years we find that:

  • The average stock that maintained a dividend made almost 3x more income than stocks that did not pay dividends;
  • The average dividend growth stock made almost 4x more income than stocks that did not pay dividends.

Manulife - dividend growth stocks example

Are there some limitations to the research?  I’m sure there are.  I bet if you adjust the time periods and the rules they applied (they assume you reinvest the dividends), you might see the impact isn’t as great. Overall though, investors shouldn’t overlook the benefit that dividends provide. Dividend growth stocks can be powerhouse machines and should belong in your portfolio.

It provides you balanced set of returns

Related to the point above, dividend growth stocks don’t just rely on the stock price going up. Instead, you make profits in two ways – through dividends (that grow in value over time) and stock appreciation.

Why’s this helpful?

Growing and reliable dividends provide you stability as an investor.  Firstly, they help put money back in your pocket even when the stock declines in value.  Secondly, they help you hold onto your investment in bad times (and avoid selling!). In fact, when the prices go down, it’s an even better time to load up on well-managed dividend companies that are cheap!

Real-Life Example: Coke

There were a lot of examples of this throughout the 2008-2009 financial crisis. Let’s take Coke as an example.

One of the world’s greatest and well-known brands has a history of paying dividends every quarter since 1920. It also has increased its dividend every year for the past 55 years! Just before the financial crisis, the stock was trading near $32 per share and gave out $0.68 in profits through dividends each year. When you do the math, that means no matter what, you’ll earn about 2% for being loyal and holding the stock.

Then 2008/09 came, and it got hit… hard. Take a look at its share price below:

KO-stock-google

At its lowest, Coke traded below $20 a share. Ouch! If you were only making money based on its share price, you would have lost over 35% of your money! But because it continued to offer its dividend, many investors held on and waited for it to bounce back. Many even saw this as a great opportunity to buy more shares from a well-run business on the cheap! You could now earn that same $0.68 a year in dividends (and increasing) for $20. That’s now 3.5% each year just through dividends!

Skip ahead to today, and Coke has recovered nicely. It’s now around $45 a share, and because of dividend growth, today you’ll earn nearly $1.50 a year/per share in income for doing nothing. Not bad at all!

Set it and forget it type mentality

Lastly, I like dividend growth stocks because they help me drown out investing noise, and allow me to take a passive approach to investing.

Do I continue to keep a pulse on what’s going on? Absolutely. But since I’m earning a steady stream of growing income each year, I’m willing to ride out the tough times.

Sometimes we are our own worst enemy. We are tempted to chase high returns and can easily get spooked if the markets decline even a little bit. Dividend growth stocks give you a reason to avoid selling and help keep your emotions in check.

Related post:    Don’t be a distracted investor – drown out investing noise

Where to find these dividend growth stocks?

So who are these great companies that increase their dividends every year? The best are called “Dividend Aristocrats.”  These businesses have increased how much they pay out for 25 consecutive years! There’s plenty of strategies to help decide which to buy (I’ll cover that in a future post) but for now, take a look at those on the S&P 500, and see if any catch your eye.

Think it through

  • How would your investing strategy change if you bought dividend growth stocks?
  • Do you have the patience to see long-term returns, rather than big swings from “hot stocks”?
  • Which dividend aristocrats appeal to you? Why?

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