Dividend Growth Investing

Dividend Growth Investing Blog

Why Dividend Growth Stocks Outperform Index Funds

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I was recently reading a series of articles written by Canadian Couch Potato on Dividend Myths.  While some of his points are valid, I think he is missing one of the key reasons that dividend growth stocks have consistently beat index funds, and why they will continue to do so.

The argument made was that there is no benefit to, say, a 6% dividend vs. a 4% capital gain plus 2% dividend.  Or a 6% capital gain for that matter.  This is true, in theory.  But it’s not that simple…  Companies that do not hand out dividends have multiple options:

Continue to stockpile, investing in low risk / low return investments

Obviously this is not their long-term strategy, but it is customary for a company to do this, sometime with a lot of money.  The problem is that I want my money used more effectively.  I’ll pick on a company I know well, Dell.  They have a market cap of $32B, with $14B in cash reserves.  That may be a nice safety net for the company, but how does it help me make more money?

Acquire new companies to achieve growth

This can go really well, or really bad.  The theory is that when a large company buys a smaller one, they use synergy to get more value out of that smaller company than they were getting themselves.  For example, maybe the larger company has great supply chain and can take the smaller company’s great product or business model, apply their own supply chain, and have a big winner.  Unfortunately it rarely works this way.  Instead, the larger company pays a huge premium for the stock (always more than the going rate), takes huge costs to integrate, and only sometimes sees a profitable business in the end.  And even if they do see a profit, it’s usually not enough to beat other ways I could have invested my money.

Develop new products and services

I’ll use Dell again as an example.  They can’t sit back and be outdone by companies like Apple, HP, and IBM so they choose to compete.  While Dell has always made a great PC and notebook, they have spent their cash expanding into MP3 players, smart phones, plasma TV’s, and many other huge failures.  This not only costs money, it destroys the brands reputability.  I would prefer to give my money only to their successful divisions, and not their failures.

Using the example above, I would prefer to give my money only to the server and notebook divisions of Dell, the iPhone/iPad/iTunes division of Apple, and the IT services division of IBM.

And this is what dividend growth companies enable indirectly.  By consistently streaming out cash, the companies are forced to only invest and spend in the highest ROE divisions of the company.  They don’t have the “luxury” of wasting my money in low return investments, or risking it in R&D.  They focus their time and money on the cash cows.

And that’s how I want my capital being used.

 

Written by dividendgrowthguy

July 12, 2011 at 5:16 am

Posted in Uncategorized

Allow Me To Introduce Myself

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The first thing you should know about me is that I’m 33 years old, married, and have two small children.  I have roughly $1,000,000 in total assets.  It’s almost entirely in stocks (individual funds and mutual funds), with about $150,000 in cash from selling my house, and about $40,000 in house equity.  I don’t include house equity in any calculations however, since that money is not working for me.

The next thing you should know is that my goal is to retire in 2 years, at age 35.  There are several reasons I desire this, which I’ll explain in the future.

I currently hold $90,000 in dividend growth stocks, with approximately $10,000 in each of nine stocks.  My plan over the next 4-5 months is to re-balance my portfolio to hold approximately $250,000 of my overall portfolio into dividend growth funds.  Assuming no market booms or busts, that will be approximately 25% of my overall net worth.  At $250,000 I would like to own between 15 and 20 different companies but I don’t plan to force it.

With my current dividend growth portfolio, I have an estimated 7.6% return on investment that equals $6844.  My target retirement payout is $36,000 per year, which is what my family can comfortably get by on.  Assuming I keep ~7% target payout as I grow my portfolio, this would require a total capital investment of $514,000.  Luckily I have 2 years left on my contract before retirement, which should be sufficient time to rebalance.

The reason I prefer dividend growth stocks is two-fold:

1. Extremely early retirement such as what I am planning for is not for the feint of heart.  It may be stressful at times, and watching your capital rise and fall would not be a fun ride when it’s your family’s future you’re watching.  But dividend growth stocks do not rise and fall in payouts, they consistently just rise.  Most have risen for at least 10 consecutive years, and in many cases it’s more than 25 years.  Some more than 50 years!  In this case, the rise and fall can be fun:  A rise means your capital goes up, while a fall means you can buy more yield for your money.

2.  Note that I consistently refer to dividend growth stocks.  Most of these have grown at 8-10% year over year for 10 years and more.  What this means is that while my initial retirement may be “just getting by,” the next year would not only increase for inflation but leave a little extra on top.  That will compound until I reach financial runaway.

Over the next series of posts, I’ll continue to explain my dividend growth strategy and dive into my actual portfolio holdings.

What about you, why do you hold dividend growth stocks?  Or if you don’t, why not?

Written by dividendgrowthguy

July 11, 2011 at 1:28 pm

Posted in Uncategorized

Hello world!

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Click here for more information about me.

Written by dividendgrowthguy

July 10, 2011 at 7:42 pm

Posted in Uncategorized