Retirees need confidence that their investment portfolios will provide a steady, sustainable stream of income, one that will rise to keep pace with inflation. High quality dividend growth stocks have fulfilled that need for decades.
The income from dividend growth stocks has the potential to continually rise from original dividend amounts over time as dividends are increased. In addition, dividend growth stocks may provide added portfolio stability and the potential to rise in value over time.
To understand dividend growth stocks, let’s look at the companies behind them. These businesses tend to sell things that people will continue to buy throughout the economic cycle. No matter how bad things might get, you probably won’t stop brushing your teeth or using dish soap. The business result is remarkable for a firm like Colgate Palmolive, which has paid uninterrupted dividends on its common stock since 1895 and increased payments to common shareholders every year for the past 52 years.
Dividend growers tend to have competitive advantages such as product leadership, dominant brands, operational excellence or customer intimacy. All of that translates into pricing power, which helps the companies to maintain profit margins, boost revenues and pay growing dividends.
By the way, the quality and stability of their earnings make dividend growers especially desirable in the eyes of investors, which tend to help make their share prices less volatile than those of other companies. As a result, the prices of these stocks tend to move more steadily and gradually rather than swinging dramatically. And that can help smooth out portfolio performance.
Dividend growth companies also tend to be well managed, demonstrating a capacity to generate more consistent free cash flow. This cash allows management to invest in growing their businesses, even as they pay rising dividends.
Historically, consistent dividend growth has also been associated with solid stock price appreciation. As a company’s dividends rise, the market bids up the price of its stock to reflect the additional income. This relationship was evident as PepsiCo’s dividend increased every year from 2000 through 2014, from $0.55 per share to $2.44 per share (a 10.45% compound annual growth rate), while PepsiCo’s stock price rose from $35.25 to $94.56 over the 15-year period ended December 31, 2014 (a 6.8% compound annual growth rate).
One common characteristic of dividend growth companies’ consistent moderate growth and steady earnings is that they’re rarely cheap. After all, investors know these companies well and are almost always interested in owning them. If a company’s prospects remain in tact and shares are priced at fair value, however, we believe a continuation of a company’s historical record of generating rising free cash flow over the long term will make them a sound investment.
While dividend growth stocks are a good fit for many kinds of investors, they are particularly attractive for retirees, who need to generate a long-term rising income to combat a long-term rising cost of living. Dividends for the S&P 500 as a whole have historically risen about 1.4 % faster than inflation during the past 50 years.
Dividend growth investing may be an important strategy to pursue for retirees seeking rising retirement income and stable returns. Bonds also remain an important portfolio component for income and stability for many investors. But bonds are paying extraordinarily low yields as a result of today’s rock-bottom interest rates. And those low rates also make bonds particularly risky right now. As rates rise, the values of outstanding bonds will fall, dealing a potentially serious blow to investors’ capital.
Meanwhile, alternative strategies like hedge funds and absolute-return funds produce little if any income that can be distributed to investors. This is due in part to their high fees. It’s not unusual for hedge funds to charge a 2% management fee, plus a 20% performance fee. Even when alternative strategies are available in a mutual fund form, their expenses are typically well above those of the average mutual fund. The complexity of these funds also exposes investors to significant new risks.
If you would like help building a portfolio of high quality dividend growth stocks with an income yield that’s higher than the S&P 500 currently offers, and with better dividend growth prospects, as part of your retirement income strategy, we may be able to help. That’s just part of what we do.
- Information on this website is not an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. References to specific securities are made for the sole purpose of explaining investment strategies and investment concepts. They should not be construed as past or current recommendations of our firm.