Apr 262012
 

I don’t know if you guys have noticed, but dividend growth investing is kind of a big deal these days. How big? Jason Segel temporarily took a break from making crappy movies to complain how dividend growth investing was stealing his thunder. Dividend growth investing was the actual sponsor of Taylor Swift’s tour last summer. Apple briefly considered calling the New iPad the DGI iPad, before the ghost of Steve Jobs appeared and talked some sense into everyone.

So, yeah, I think dividend growth investing is kind of a big deal.

These days, in the PF-o-net (which is totally a word, thanks to the magic of dashes) there seem to be two distinct camps. In one, we have the dividend growth guys. They love about 30 different stocks, and they love the HELL out of them. We all know they’ve pleasured themselves thinking of Johnson and Johnson shares at least once, probably while using a product from that particular company as lube. They have a simple criteria: find stocks that have consistently raised dividends for a certain period of time, and make sure they aren’t paying out all their money to sustain this dividend.

Meanwhile, we have their opponents, the passive investors. You shouldn’t even try to beat the market, see, since a moron like you has no chance. They’re content to just buy the ETFs that mimic the performance of the major indices and just call it a day. They have a valid argument, especially if you know nothing about investing, but for the purposes of this blog post, we’ll ignore indexers. They’re boring and I’m pretty sure they smell like they forgot their deodorant today.

As you can probably figure out, I’ve got a bit of a problem with dividend growth investing. I don’t think it’s the worst system of investing in the world – after all, some moron I know actually buys stocks when they’re out of favor and beaten down. Generally, the stocks they buy are, at least from a P/E perspective, somewhat fairly valued. They’re also generally the bluest of blue chips, their favorite stocks generally have market caps bigger than my gigantic penis. FINALLY, A PENIS JOKE ON FINANCIAL UPROAR.

So, what’s my problem again? Dividend growth investors are buying stocks that are growing the dividend, usually at a level higher than inflation, and are buying them at reasonable valuations. That seems reasonable. And there, lies the first problem with the system – the reasonableness of it. If an investor buys McDonalds (after a 502% gain in the past 9 years) or Johnson and Johnson, their chances of a large capital gain is virtually non-existent. McDonalds isn’t going up another 100% anytime soon. Neither is Johnson and Johnson or Pepsi or any of the other dividend growth favorites. They’re just too large. Yes, I realize McDonalds has just completed a hell of a run, and Apple is the largest company in the world after their epic run. But, these companies are the exception, not the rule.

Secondly, we have the obsession with the dividend. I can get that. I like dividends too. The problem is with the almost singular focus on it. As long as a company is growing the bottom line and their investors get that yearly dividend hike, dividend growth investors are happy to buy, all other metrics be damned. Paying $10 for every $1 in assets? THAT’S ALL GOODWILL BABY! Buying at a 52 week high? WHO CARES, DADDY LIKES DIVIDENDS.

Dividend growth investing has such a focus on the past that I bet it was invented by a bunch of fat housewives who used to be hot. Look at how good this company has been. It has grown revenues and profits and dividends SO MUCH over the past decade/quarter century/millennium that they’re just bound to do it again. Ignore the fact it’s a giant behemoth. Ignore the fact that past performance is not indicative of future results. Ignore the fact that you’re resigning yourself to small capital gains by buying a company that’s been successful for decades.

Anyway, what’s the solution? What would I rather you do? It’s simple: create your own dividend growth. It’s easy. All you need to do it reinvest your dividends.

Say you buy $20,000 worth of preferred shares giving you an average yield of 6.5%. After the first year, you’d make $1300 in dividends. If you take that $1300 and buy another preferred share yielding 6.5%, you’ve increased your earnings by $34.50 in year 2. To match your success, a dividend growth investor would need a stock yielding 3% to grow the dividend by 11.5% in year 2 to match your 6.5% growth rate, and they still won’t have as much, since their dividend was smaller to begin with.

Fast forward to year 3, where our preferred share investor is enjoying yearly dividends of $1474.49 off his compounding returns. It’s too late for me to figure out exactly how much growth our dividend growth investor needs to keep up, but it’s definitely a pace that’s difficult for most companies to maintain.

The math on this is fairly simple. If you start with a much higher dividend offered by a preferred share, (or a bond if you’re so inclined) and reinvest the payout in a similar preferred share, you’ll beat all but the golden boys of dividend growth investing, at least when it comes to yield.

Want some capital gains exposure in there too? Hey, there are all sorts of stocks out there they pay generous dividends, you’re just missing the growth. Rogers Sugar is a great example. God, I love that stock. Thanks to Canada’s income trust boom of 2002-2006, I bought a stock that paid a 10% distribution for years, with only a slight amount of growth over that time. I will take a steady 10% dividend over a 3% dividend that’s growing any day of the week, and so should you.

Tell everyone, yo!

  18 Responses to “Can I Suggest An Alternative To Dividend Growth Investing?”

  1. There’s probably a ways to go yet, but I am starting to wonder if the fervour for this small handful of dividend-growth stocks is leading to over-valuations and poor future returns. I saw the “one-decision” description in one article not too long ago… echos of the Nifty Fifty.

  2. Nelson I love you, you are the only personal finance blogger that can make investing interesting to me.

  3. And here comes my stock investing newbieness to the forefront. I guess what I don’t really understand is if the preferred share gives a dividend of 6.5%, why would anyone ever want to invest in the stock that only offers a 3% dividend, if all someone cares about is the dividend. What is the deterrent to investing in preferred shares over regular shares?

  4. But preferred shares, unless convertible, have zero upside – not to mention that the value of a preferred share or bond will likely not keep pace with inflation. 

    Dividend growth investing makes sense to me, but it’s pretty boring in so far as a long-term strategy. While I appreciate the idea of receiving cash flows from a business, especially if those cash flows increase over time, I think dividends greatly increase the market price of any company’s stock (as people chase dividends) which make them a poor alternative when you have many years or even decades’ worth of accumulation before you start making withdrawals. 

    • I have several preferred shares I bought at a discount to par that are sitting on 10-30% capital gains. But, for the most part, you’re right. However, preferred shares do offer additional capital protection if the common stock falls out of favor. 

      There are so many investors piling into about 20 dividend growth names that I’d argue, as Potato did below, that they’re pretty fully valued at this point. 

  5. […] 8. Can I Suggest An Alternative To Dividend Growth Investing? @ Financial Uproar. […]

  6. Do you really think dividend stocks are that popular?  Jason Segal popular?  I hear more people talking about Apple and other tech stocks.

    Loving a dividend growth stock doesn’t mean you have to buy it right now.  The idea is to buy dividend growth stocks when they are value priced and hold them for the growing income.  Value priced meaning something like buying in early 2009 and then having the patience to wait for another meltdown before you buy again.  

    I agree that now is not the time to buy most dividend growers.  But I’d rather hold cash and wait for prices to come down than jump into a different investment strategy.

  7. But I found in one of blog posts out there saying be cautious before buying those Apple shares. They have given a really technical explanation which I couldn’t understand at all.

  8.  This is really wonderful post. But the thing is some of the points you have raised are completely difficult to  understand at all. Anyway thanks for the post.

  9. […] far, so sensible. However, as blogger Financial Uproar writes,  a proponents of division expansion investing can infrequently seem rather astigmatic (and […]

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  12. […] a fan of dividend growth investing. How about looking forward, not backward, dividend growthers? I suggested an alternative. It’s pretty good, I […]

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