Dividend Growth Investing is a strategy that allows investors to purchase dividend stocks that have a long history of increasing their dividend payments to shareholders. These stocks have sound business models which have withstood the test of many recessions. Most of the dividend growth stocks that I follow represent strong consumer brands like Coca Cola (NYSE:KO), Aflac (NYSE:AFL) or Procter and Gamble (NYSE:PG) which people use on a daily basis. Recessions do affect these companies, but not to the degree that a car manufacturer is affected. As a result of this stability in sales and earnings, these stocks can afford to not only pay a stable dividend every quarter, but also share their prosperity with shareholders by consistently increasing the payments every year. Stocks that regularly increase their dividends tend to be more careful with the way the allocate their financial resources, because they realize that cutting or eliminating the dividends to shareholders would result in lost confidence in company’s management which could take years to recover from.
Dividend Growth Investing is also about consistency and getting a decent dividend growth and dividend yield. The balance between dividend growth and dividend yield is more important as opposed to focusing exclusively on yield. A dividend stock like Pepsi Cola (NYSE:PEP) yields only 3.10%. However if the stock continues increasing its dividends by 11-12% over the next decade, your yield on cost would end up at over 12% in twelve years. As a dividend investor your main goal is to generate an income stream, which is increasing above the rates of inflation. In order to achieve that, you have to select sound dividend stocks, which represent strong brands and which could afford to pay you an increasing payment year after year.
For that reason I don’t believe in chasing high-yielding stocks. Most higher yielding stocks indicate a high chance that the dividends could be cut. Several high-yielding financial stocks like BAC, C and KEY provided very high dividend yields, which were never paid to shareholders, as the dividends were cut. Other stocks like oil tankers, and higher yielding Canadian royalty trusts which pay out very high dividends, can only afford to do that because their payments vary and are not as consistent. As a dividend investor you have already taken a considerable amount of risk by purchasing individual stocks. You want to minimize that risk by selecting stocks which could not only maintain but also increase your dividend income. You don’t want to guess whether you will be paid a large dividend next quarter or whether you won’t be paid anything at all.
If you had to choose between a stock which is yielding 6% but not growing its dividend versus a stock yielding 3% but growing its dividend by 7% per year, which one would you choose? If you are looking for current income, you might choose the higher yielding stock. But over time the increase in dividends in the second stock would provide for a much higher yield on cost compared to the second stock.