Why Consider Dividend Growth Investing?
Dividend growth investing is increasingly popular in the US and worldwide. The concept is simple and easy to understand. An investor buys a basket of stocks that annually increases the dividend. This strategy is a long-term buy-and-hold strategy. In contrast, it is the opposite of a trading strategy where an investor rapidly buys and sells stocks. Some investors think of dividend stocks as something that only retirees buy for income. However, some of the largest tech companies pay dividends, including Apple (APPL) and Microsoft (MSFT). Hence, investors can buy growth stocks that also pay a growing dividend.
Why Dividends?
Do dividends matter to investors? The short answer is yes for a few reasons. First, over time, stocks that pay dividends tend to outperform ones that don't pay dividends with lower volatility as measured by beta. The difference in total return is even more significant for comparing stocks that pay growing dividends and stocks that don’t pay dividends. Furthermore, research has shown that dividend and dividend growth stocks significantly outperform stocks that cut or eliminate dividends.
The reason for this is that companies that cut or eliminate dividends are often performing poorly. In some cases, this poor performance is due to changing economic conditions. For instance, energy companies performed poorly in 2020 due to the COVID-19 pandemic. Lower revenue and earnings caused many energy companies to stop paying a dividend. However, in many cases, it is because the company is facing increasing competition or changing technology. For example, Kodak's core technology was film, and digital cameras and smartphones made film obsolete.
Another reason why dividends matter is dividends can be used to determine valuation. An estimate of a fair value can be calculated using the dividend per share and the expected constant growth rate.
Dividends also indicate if the company is doing poorly or well since cash must be used to pay the dividend. Research has also shown that dividend stocks perform better than non-dividend-paying stocks in down markets.
Types of Companies
Not all companies pay a dividend or a growing dividend. In the US, there are over 6,000 stocks listed on stock market exchanges. Of these, more than 3,500 pay a dividend, and only about several hundred pay a growing dividend for 5+ years. The fact points to the difficulty a company has for growing the dividend over a more extended period.
There are lists of companies that pay a dividend for extended periods. One group of stocks that are well known as dividend growth stocks are the Dividend Aristocrats. The stocks on this list have raised the dividend for 25+ years. In addition, the stocks must meet other criteria, including being a member of the S&P 500 Index and having a market capitalization of $3 billion or more. Currently, there are 65 stocks on the Dividend Aristocrats list.
Investors can buy the individual stocks or buy an exchange-traded fund (ETF) that owns the entire list.
A Top Dividend King Today
An even more exclusive club of dividend growth stocks is the Dividend Kings 2021 list. These are stocks that have paid a growing dividend for 50+ years. There are only 32 stocks on this list. It is challenging for a company to raise the dividend for 50 or more years. Typically, a company must have a substantial competitive advantage to overcome economic cycles and competition.
One top Dividend King today is Johnson & Johnson (JNJ). The company is a global healthcare company with three primary business segments: Consumer Health, Pharmaceutical, and Medical Devices. Most investors know the company through its consumer health business. Major brands include Band-Aid, Neosporin, Tylenol, Zyrtec, Sudafed, Motrin, Benadryl, Pepcid, Listerine, Aveeno, Neutrogena, Stayfree, Carefree, o.b., and Clean & Clear. However, Johnson & Johnson's other two segments are much larger. For example, some of the drugs that Johnson & Johnson sells are blockbusters, with over $1 billion annually in sales.
Johnson & Johnson’s stock price is relatively flat for the year, with a gain of ~3.5% year-to-date. However, results impacted by COVID-19 have pressured the stock price. In addition, Johnson & Johnson is faced with lawsuit risks from opioids and talcum powder that are also pressuring the stock price. The current quarterly dividend rate is $1.06 per share for an annual rate of $4.24 per share. The forward dividend yield is about 2.6%.
The company’s dividend is relatively safe. The forward payout ratio is approximately 43%, a good value. Furthermore, Johnson & Johnson is one of two triple-AAA-rated companies from credit agencies. For this reason, Johnson & Johnson is often considered one of the best dividend growth stocks.
Johnson & Johnson recently announced that it would split into two companies. The Consumer Health business will be divested, leaving the Pharmaceutical and Medical Device business. Johnson & Johnson will continue to grow organically through R&D and approvals for new medications and indications. The company will also probably buy smaller companies adding to its growing portfolio of products.
- Market Capitalization: $428.82 billion
- Stock Price: $162.89
- Dividend Yield: 2.6%
- Payout Ratio: 43.3%
Summary
Dividend growth stocks should be considered by all investors, not just those in retirement. The reason is that they can provide excellent long-term returns with lower volatility. There are hundreds of stocks to pick from using this investment strategy, including many well-known ones.
Author Bio: Dividend Power is a self-taught investor and blogger on dividend growth stocks and financial independence. Some of his writings can be found on Seeking Alpha, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial blogs. He also works as a part-time freelance equity analyst with a leading newsletter on dividend stocks. He was recently in the top 3% out of over 8,116 financial bloggers as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.
Disclaimer: Dividend Power is not a licensed or registered investment adviser or broker/dealer. He is not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
