6 Reasons to Become a Dividend Growth Investor

The American stock market has been one of the most significant long-term wealth generators in history. It has a record of a compound annual growth rate of 9% since the late 1990s. Even after the Great Depression of 1929 and other stock recessions and stock collapses, the U.S. stock market has always performed well for investors in the long run. Many people have different strategies for investment. Some like to speculate stock in short term periods such as day trading or trying to time the market, and some prefer to let the experts do their job such as fund managers to manage their money in the form of a mutual fund. However, an average person can learn how to invest safely using dividend growth investing.

Dividend Growth Investing is a good strategy if you want to invest on your own. It is not even that difficult to learn, and many ordinary people actually do it. By always being ready and staying disciplined, investing in a dividend growth stock can provide a stable, growing income stream that can fund your needs, desires, and retirement over time. I adopted dividend growth investing as my investment strategy because of the simplicity and how practical it was. Here are six reasons why you should become a Dividend Growth Investor. Moreover, I will also discuss the benefit of becoming a dividend growth investor throughout my investment journey.

1. Dividends are a Major Source of Long-term Market Returns.

The first reason for being a dividend growth investor is the historical fact of dividends to a portfolio's total return. Most people believe that stock appreciation was the underlying goal of investing in the stock market. However, did you know that from 1930 through 2017, dividends accounted for almost 42% of the S&P 500 Index's total return? This was a study by Hartford Funds that proves to us that dividends are important.

Moreover, if you actually take a look at the chart below shows that at certain times such as the 1970s and 2000s, dividend accounted for well half of the market's returns. This can happen when stock prices stagnate or decline over some time; however, dividend income keeps coming in.

I was surprised by how dividends were the primary source of the long term market returns. This was why I started a dividend growth portfolio in 2015, and feel that dividend growth investing is right for me. By sticking to this strategy, I was able to perform better than when I was regularly buying and selling stocks (trying to time the market). I don't have to worry about it now since my focus is on the dividends (passive income) that my portfolio generates.

2. Dividend Growth Investing Tend to Outperform the Market in the long term.

Yes, you read it right. Dividend Growth Investing tends to outperform the market in the long run. Companies that pay and grow their dividends have historically outperformed non-dividend stock. In the table below, Hartford Funds shows how, from 1972 through 2017 that dividend-paying stocks returned 9.25% per year, beating the S&P 500's annualized return of 7.7% and 2.6% annualized return of stocks that did not pay dividends.

I also show a chart below showing how Dividend Aristocrats companies have beaten the S&P 500 performance by a considerable margin. If you have invested $100 in Dividend Aristocrats in the year 1990, you will end up with $1,800 in 2014. While a $100 invested in the S&P 500 index in 1990 would result in you having only $800 in 2014. This shows the vast difference in return performance between both of them.

You are probably thinking how that is possible when theoretically non-dividend paying stocks reinvest all their earnings and cash flow into their businesses. The answer to this lies in management. For example, a company like Facebook Inc. (Ticker: FB), which is growing rapidly while earning a very high margin, may seem like a better choice than a dull dividend growth stock. However, non-dividend paying stocks focused on growth can also run into a number of unexpected challenges. Sometimes their business models can reach a point of market saturation sooner than expected, or it could be a shift in technology, consumer preferences, or the competitive landscape.

If the stock was richly valued, these businesses could struggle to find profitable, needle-moving growth opportunities. This can result in management making poor capital allocation decisions, such as making expensive acquisitions that might not be beneficial to the company. Indeed, a company is not immune to risks simply just because of paying dividends. However, many businesses have managed to pay stable or growing dividends for over 20 years. They kept their payouts intact despite recessions, wars, technological shifts, significant changes in consumer habits, and more.  

3. Dividend Growth Investing is Remarkably Effective for Retirement.

If you want to have a source of income for your retirement, then dividend growth investing is suitable for you. This is perhaps the biggest reason why most people want to become a dividend growth investor. They want to be sure that their portfolio will ensure a good standard of living during their retirement.

Dividend growth investing gives the investor the ability to earn passive income from the dividends payout without selling the stocks. This reason has led many people to create a dividend growth portfolio because people that are soon going to retire usually need a source of income coming monthly. A dividend growth portfolio provides these needs since the dividends payout from a portfolio can also be considered a passive income source.

I also like this reason because, as a Dividend Growth and Value Investor, I tend to want to keep the stocks that I purchased forever. Moreover, I can transfer the dividend income from my brokerage account to my checking account and use it for my everyday expenses. I think having a dividend growth portfolio will be incredibly useful for my early retirement since I can use the passive income (dividends) when I need to. I can use the cash it provides for paying my expenses or merchandise I want to purchase.

Also, I can always let my children or grandchildren inherit my dividend growth portfolio, giving them the ability to earn those passive incomes if I passed away. The feeling of owning a dividend growth portfolio is like having a Magic Goose that lay a golden egg every day, but in this case is in the form of passive income that you can spend it, give it to charity, reinvest it or add it on your savings.

4. Dividends Growth Investing is More Preferred during the Stock Market Crash.

During the stock market's meltdown, strong dividend stocks tend to hold their value compared to the non-dividend paying stocks. The reason is because of its dividend payment. If you choose the right dividend growth companies, it will still pay its dividend to your portfolio. This, of course, also depends on the company's underlying investment thesis to remain intact, being able to grow its dividend sustainably and securely over time.

Many people usually rush to sell their stocks during a market crash since everything is plummeting. You don't have to worry when you own dividend growth stocks. You can use this market turmoil as an advantage to purchase stocks that dip with the dividend you received or add additional capital towards your dividend growth portfolio. 

I like the fact that I can still earn my passive income without worrying whether the stock market is going up or down since I will be making those passive incomes (dividends). I don't have to worry about my portfolio's price performance and focus on the dividends rolling in. When the market is terrible, the dividend-paying stock can be beneficial to own.

For example, let's say you hold two stocks of $100,000 investment, one is a dividend-paying stock which Johnson and Johnson (Ticker: JNJ) which you invest $50,000 (paying 3.0% dividend yield) and the other is not a dividend-paying stock which is Crocs Inc. (Ticker: CROX) and you also invest $50,000 invested. Let's say the market went into a collapse, and both stocks you own went down 50% in value. Your Johnson and Johnson stock dividend yield would increase to 6% at that price (assuming that dividend per share is still the same). This gives the dividend-paying stock an advantage to earn passive income and, of course, invest at more attractive dividend yield, adding more shares either into the original stock or some other undervalued dividend growth stock.

As a dividend growth investor, the dividends you received are tangible and permanent benefits that no stock crash can undo. However, you cannot get cash from your Crocs Inc. stock, and if you need the money, you'll need to promptly sell the stock at an unfavorable price, losing 5 to 10 years of the unrealized profit. You gained nothing for all the patience and savings over time.

My suggestion is you should not sell stocks during market turmoil but instead purchase more stocks at the time. Investors can many times be hurt by impulses and emotions, often buying and selling too quickly. It is much simpler to avoid these mistakes by purchasing and holding a high-quality dividend-paying stock that raises dividend payment consistently year after year. Real money sent directly to your brokerage account is very attractive, especially when the world is falling apart from you.

5. Dividend Growth Stocks vs. Fixed Income

Some might argue if you need passive income, why not just buy Bonds or CDs, and you don't have to worry about the stock price fluctuates. Well, my reason is that dividend growth stocks tend to increase their dividend payout each year. Let's say you bought $1000 of dividend growth stocks such as Coca Cola Co., and the dividend yield might be around 3%, which means you will receive $30 in dividend income. However, if Coca Cola Inc. increases its dividend by 5% every year throughout the future. The yield to cost from Coca Cola Co. will be 12.95% twenty years to the future, which means you will be earning $129.5 on your $1000 investment.

Compare this to bonds if you invest $1000 in bonds that yield 4.000 coupons for 20 years. You would only make $40 each year, and in the 20th year of holding the bonds, you will only still be making $40. This shows that holding bonds as an investment doesn't have the growth potential like a dividend growth stock. Moreover, not only the dividend income will be different when investing in a dividend growth stock. It also has the potential to have a capital appreciation, making the future price different from bonds.

6. Management is More Careful with Dividends vs. Non-Dividends 

When a company pays dividends to its shareholders, it enforces discipline. A CEO needs to be more prudent since he/she needs to choose the more cost-effective option with the better promise of expanding earnings. This physiological caution is responsible for the superior returns generated by dividend stocks over long periods. 

Charlie Munger once commented that it would be better for Berkshire Hathaway to pay out dividends after Warren Buffett's death. This would prevent capital reinvestment risk that would pay most of its company earnings as dividends. The management cannot be screwed up if the money is already given out as dividend payout.

Closing Thoughts on Dividend Growth Investing.

Building wealth through investing in the stock market sounds simple in theory. However, many investors failed in trying to beat the market. This is the reason why dividend growth investing might be suitable for you. Dividend growth investing is not complicated and can be applied by anyone. I decided to become a dividend growth investor after researching a suitable investing method I can apply.

There are many benefits to becoming a dividend growth investor. Studies show how dividend growth stocks outperform the market; and prove how dividends are the major source of long term market returns. Aside from being efficient in beating the overall market performance, it provides a stream of passive income that can be great for your retirement. Moreover, you can also let someone else like your children or grandchildren inherit the dividend growth portfolio you have built without selling a single share. 

I hope this article inspires you to become a dividend growth investor and start investing as soon as possible. Remember, the earlier you start, the better result you will get in the future. So please do not procrastinate and start letting compound interest work into your advantage.