Dividend growth is a strategy that focuses on investing in companies that pay dividends and increase them over time. Dividends are payments that companies make to their shareholders from their earnings. Dividend growth investors seek to benefit from both the income stream and the capital appreciation of their stocks.
Why dividend growth?
Dividend growth investing has several advantages over other strategies. Some of them are:
- Dividend growth stocks tend to be more stable and less volatile than non-dividend-paying stocks. This is because dividends signal the quality and profitability of a company, and also provide a cushion during market downturns.
- Dividend growth stocks can provide a steady and growing income stream that can help investors meet their financial goals, such as retirement or education. Dividends can also be reinvested to compound the returns over time.
- Dividend growth stocks can outperform the market in the long run. According to a study by Ned Davis Research, dividend growers and initiators delivered an annualized return of 10.07% from 1972 to 2019, compared to 7.35% for the S&P 500 index.
- Dividend growth stocks can offer some protection against inflation. As companies raise their dividends, they increase the purchasing power of their shareholders. Dividends can also act as a hedge against deflation, as they provide a positive return even when prices fall.
How to find dividend growth stocks?
There are several criteria that dividend growth investors can use to screen for potential candidates. Some of them are:
- Dividend yield: This is the annual dividend per share divided by the share price. It measures how much income an investor can get from a stock. A higher yield may indicate a higher return, but also a higher risk. A lower yield may indicate a lower return, but also a lower risk. A good range for dividend yield is between 2% and 6%.
- Dividend growth rate: This is the annual percentage change in the dividend per share. It measures how fast a company is increasing its dividends. A higher growth rate may indicate a higher future income and capital appreciation, but also a lower current yield. A lower growth rate may indicate a lower future income and capital appreciation, but also a higher current yield. A good range for dividend growth rate is between 5% and 15%.
- Payout ratio: This is the percentage of earnings that a company pays out as dividends. It measures how sustainable and safe a dividend is. A lower payout ratio may indicate a more conservative and reliable dividend policy, but also a lower income potential. A higher payout ratio may indicate a more aggressive and generous dividend policy, but also a higher risk of dividend cuts. A good range for payout ratio is between 30% and 70%.
- Earnings growth rate: This is the annual percentage change in the earnings per share. It measures how profitable and growing a company is. A higher earnings growth rate may indicate a more dynamic and innovative company, but also a higher valuation and volatility. A lower earnings growth rate may indicate a more mature and stable company, but also a lower growth potential and competitiveness. A good range for earnings growth rate is between 5% and 15%.
Some examples of dividend growth stocks are:
- Johnson & Johnson (JNJ): This is a diversified health care giant that produces consumer products, medical devices, and pharmaceuticals. It has a dividend yield of 2.48%, a dividend growth rate of 6.29%, a payout ratio of 55%, and an earnings growth rate of 8.16%. It has raised its dividend for 59 consecutive years.
- Microsoft (MSFT): This is a leading technology company that develops software, hardware, cloud services, and gaming products. It has a dividend yield of 0.86%, a dividend growth rate of 10.24%, a payout ratio of 30%, and an earnings growth rate of 17%. It has raised its dividend for 18 consecutive years.
- Starbucks (SBUX): This is the world's largest coffee chain that operates in more than 80 countries. It has a dividend yield of 1.54%, a dividend growth rate of 13.89%, a payout ratio of 51%, and an earnings growth rate of 18%. It has raised its dividend for 11 consecutive years.
Conclusion
Dividend growth is a strategy that aims to invest in companies that pay dividends and increase them over time. It has several benefits, such as stability, income, performance, and inflation protection. It also requires some criteria, such as yield, growth rate, payout ratio, and earnings growth rate, to find suitable stocks. Dividend growth investing can be a rewarding way to build wealth and achieve financial freedom in the long term.