Is Dividend Growth Investing a Magic Formulae or Over-Hyped Strategy?
This is an opinion piece covering the merits and drawbacks of the investing strategy known as ‘Dividend Growth Investing’.
What is Dividend Growth Investing?
Dividend Growth Investing, which I’ll call DGI for short, is a popular stock-picking strategy consisting of a detailed screening method to identify companies that have paid regular and growing dividends to investors over an extended period of time.
That’s the DGI method in a nutshell, so what does it look like in practice?
Dividend Growth Investing, step-by-step
First of all, an investor needs to define their criteria of what an excellent dividend growth company looks like.
Criteria could include:
- How long has the company been in business?
- How long has the company paid dividends?
- How many times has the company failed to pay or cut a dividend?
- How consistently has the company grown its dividend?
A DGI investor will need to create a rule based upon each of these conditions which they feel is relevant. Such as ‘been in business for 20 years or more’ ‘paid dividends for 10 years or more’ ‘never failed to pay a dividend’, and so on.
Believe it or not, some companies have successfully managed to pay an increased dividend every single year since they began paying dividends. It’s not a long list, but some companies have made it to that prestigious group.
This group of companies is prized by DGI investors, who believe that these companies have demonstrated a superior ability to grow the value of their income in a consistent manner, which could indicate that they are lower risk investments.
Secondly, a DGI investor needs to identify a stock screening tool online to help them with their search.
It’s not enough to simply define some rules – an investor needs a tool that can quickly and efficiently sort through companies and highlight stocks that meet the input requirements.
These can be found easily online by searching for a ‘stock screening’ tool, and I recommend you use one as crawling manually through the financial statements of listed businesses would otherwise be a very painful and time consuming process!
The third step is to execute trades to buy the relevant shares and build the DGI portfolio.
Although the stock selection aspect of the DGI strategy is quite specific to Dividend Growth Investing, the portfolio management techniques are essentially just a basic ‘buy and hold’ strategy.
DGI investors will usually jettison a company from their portfolio if they do violate a rule such as failing to pay a dividend or failing to increase dividends. However, this can begin to look like a ‘buy high, sell low’ rule, as such businesses will likely be trading at lower valuations than they were purchased for due to their subsequently disappointing performance.
Is Dividend Growth Investing an Effective Technique?
In principle, if academic theories about asset pricing are correct, then the Dividend Growth Investing approach should not provide an advantage over ordinary stock picking.
Yes, by restricting your purchases to a group of high performing, reliable dividend payers, you may reduce the risk of your portfolio. But your reward will probably be lower too.
Dividend-paying companies with a great track record are valued by many investors, not just DGI followers, and therefore their shares command a higher price. This higher price means that DGI investors will be paying a premium to acquire these shares in the first place, which limits future returns.
Dividend growth investing is one of many ways to pick stocks and I don’t necessarily recommend it as being better or worse than other stock picking methods – it’s simply one way of doing it, but other investors prefer other approaches, such as Value Investing or the ‘Dogs of the Dow’ strategy.