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The greatest enemy of the fixed income investor is inflation. If you receive the same amount of income year after year, but you need to spend more and more to buy the same goods and services, then your purchasing power erodes more and more.

One way to counteract the erosion of your purchasing power is to receive more income every year. If inflation is 3%, but you receive 4% more each year, then your purchasing power is preserved (and might even increase).

One way an investor can receive more income every year is to invest in dividend growth companies. The phrase "dividend growth company" means "growth of the dividend." Growing dividends means more income.

How can an investor discover which companies grow their dividends every year? David Fish publishes lists of Dividend Champions (25 years or more), Dividend Contenders (10 to 24 years), and Dividend Challengers (5 to 9 years) available for free here, and I publish many useful statistics about dividend growth companies at my dividend web site.

Dividend growth companies often grow their dividend by a different percentage each year. For example:

year

dividend

increase

percent increase

1

$1.00

2

$1.64

$0.64

64

3

$1.83

$0.19

11.585

4

$2.28

$0.45

24.59

5

$2.91

$0.63

27.632

6

$3.64

$0.73

25.086

7

$4.26

$0.62

17.033

8

$4.90

$0.64

15.023

9

$5.37

$0.47

9.592

10

$6.20

$0.83

15.456

11

$6.78

$0.58

9.355

12

$7.42

$0.64

9.44

13

$7.52

$0.10

1.348

14

$7.84

$0.32

4.255

15

$8.73

$0.89

11.352

The dividend growth is not "smooth." It is "bumpy."

What would smooth growth look like? It would look like this:

year

dividend

increase

percent increase

1

$1.00

2

$1.17

$0.17

16.739

3

$1.36

$0.20

16.739

4

$1.59

$0.23

16.739

5

$1.86

$0.27

16.739

6

$2.17

$0.31

16.739

7

$2.53

$0.36

16.739

8

$2.95

$0.42

16.739

9

$3.45

$0.49

16.739

10

$4.03

$0.58

16.739

11

$4.70

$0.67

16.739

12

$5.49

$0.79

16.739

13

$6.41

$0.92

16.739

14

$7.48

$1.07

16.739

15

$8.73

$1.25

16.739

This company grew its dividend by the same percentage every year.

Note that the dividends in year 1 and in year 15 were the same, but the way you got from year 1 to year 15 was much smoother when the growth percentage is the same every year.

This "smooth" rate is called the Compound Annual Growth Rate, or CAGR. I believe this gives us a useful metric with which to compare various dividend growth companies.

Let's pick a 10-year period, from 2001 to 2011. Which companies had the highest CAGRs in that period? You might be tempted to buy those companies. After all, what's not to like about Waste Management's (NYSE:WM) 10-year CAGR of 63.438%?

Plenty, as it turns out.

Let's take a deeper look into that CAGR. There was no change in the dividend from 2001 to 2003. From 2003 to 2004, the dividend grew by 7400%, then from 2004 to 2011 it grew by between 6.667% and 12.5% per year. That is quite a bumpy ride.

Is there a way to quantify "bumpiness"? Yes. My article "How Bumpy Are Your Dividends?" does that.

WM's CAGR of 63.438% came with a bumpiness of 2321, which is the highest bumpiness of any dividend growth company I know.

This made me wonder - does high CAGR always come with high bumpiness?

Not necessarily. This chart shows which CAGR's come with which bumpiness.

WM is indeed the outlier, both in CAGR and in bumpiness.

If you are willing to give up a little CAGR, you can do so at much lower bumpiness. One company, UnitedHealth Group (NYSE:UNH), has a CAGR of 55.312% with a bumpiness of 381. (UNH had 6 years with no change in the dividend.) Another company, AmeriSourceBergen Corp. (NYSE:ABC), has a CAGR of 53.705% with a bumpiness of 84. (ABC had 2 years with no change in the dividend.)

High CAGR can mask some sins. It is possible to have some dividend cuts during a period of high CAGR. For example, Progressive Corp. (NYSE:PGR) has a CAGR of 32.822% with a bumpiness of 52, but it paid $0 in dividends in both 2007 and 2009.

Personally, I prefer a smoother ride, and I prefer to buy dividend growth companies that raise their dividend each and every year for a minimum of 10 years. It's hard to ignore dividend growth companies like Procter & Gamble (NYSE:PG), with a CAGR of 10.914% with a bumpiness of 2, Johnson & Johnson (NYSE:JNJ), with a CAGR of 12.385% with a bumpiness of 4, and Wal-Mart Stores (NYSE:WMT), with a CAGR of 17.869% with a bumpiness of 9.

Conclusion

The title of this article asks the question, "Should I buy high-CAGR dividend growth companies?." I can't tell you what you "should" buy. I can show you that high CAGR sometimes comes with high bumpiness, but only you can choose the "sleep well at night" (SWAN) compromise between the two.

Source: Should I Buy High-CAGR Dividend Growth Companies?