There are a lot of different ways to slice and dice stocks. You have growth, value, momentum, blue chips, small caps, sectors, industries… The list goes on and on.
Dividend growth stocks aren’t mentioned enough. Most people talk about growth or value. Dividend growth is a combination of looking for high quality, fair or better prices, future growth, and shareholder-friendly management.
Reason 1: Dividend Growth Stocks Have Historically Beaten the Market
Now that’s a claim few investment strategies can make. The evidence shows that dividend stocks in general – and dividend growth stocks in particular – have outperformed the market over long periods of time.
In a study by Nuveen Investments from 1972 through 2014, dividend growers and initiators generated returns of over 9% a year, while non-dividend paying stocks generated returns of under 3% a year. What’s more, the dividend growers and initiators generated these returns with lower standard deviations.
The Dividend Aristocrats Index also shows the historically market-beating total returns of dividend growth stocks. The Dividend Aristocrats Index is comprised of 51 stocks that have paid increasing dividends every year for 25 or more consecutive years. It includes many well-known industry-leading stocks like Coca-Cola, Wal-Mart, Procter & Gamble, Johnson & Johnson, and ExxonMobil (among many others). You can sometimes find these amongst Motley Fool stock picks.
You might think of these as ‘slow growth’ businesses, but the Dividend Aristocrats have outperformed the market by over 2 percentage points a year over the last decade.
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Reason 2: Dividend Growth Investing Focuses On The Long-Run
Dividend growth investing is not a short-term strategy. Businesses that pay rising dividends year after year are best held for the long run. There is no point in rushing in and out of stocks if you are holding them for dividend payments.
Dividend growth stocks reward long-term investors by increasing dividend payments year-after-year. This slow-but-steady growth does not accrue to investors who are constantly switching stocks.
The benefit to buying and holding for the long run is you accrue less frictional costs. Every time you buy or sell a stock, you pay your broker a commission. You also will likely incur additional losses from slippage. When you don’t sell, you get to compound the money you would be paying in fees (and capital gains taxes) in your investment – think of these as interest-free loans.
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Reason 3: Dividend Growth Focuses You On The Underlying Business
You’ve seen that dividend growth stocks have historically outperformed the market. This raises an interesting question: Why has dividend growth investing been so successful? I believe that’s because dividend growth stocks tend to be superior businesses.
For a company to pay rising dividend income every year, it must have a strong competitive advantage and a clear growth runway. It must also be generating sizable cash flows. Finally, its management must be shareholder-friendly enough to want to return cash to shareholders in the form of dividends.
These traits make dividend growth stocks stand out from most other businesses. Many dividend growth stocks (and especially Dividend Aristocrats) are the leaders in their industry. They are high-quality businesses.