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.