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In his bestseller Outliers: The Story of Success, Malcolm Gladwell explained the idea that success in many fields comes from factors that may be unusual in the population at large, but that are quite common among the outliers themselves. From the book's flap copy:

The lives of outliers - those people whose achievements fall outside normal experience -follow a peculiar and unexpected logic.

The definition of outlier is quoted at the very beginning of the book. An outlier is:

1. Something that is situated away from or classed differently from a main or related body;

2. A statistical observation that is markedly different in value from others of the sample.

Gladwell's research was into success attributes of humans in different fields. Sometimes the attributes are surprising, such as that success in elite Canadian amateur hockey is correlated to the birth months of the players. (The unexpected reason is the way age cutoffs are applied at young ages for participation in the various levels of youth hockey programs. Kids born in January-March get advantages throughout their developmental years.)

Sometimes success attributes are not surprising. In a variety of fields, the elite performers simply practice longer and work harder than equally talented competitors. This shows up among computer programmers, violinists, pianists, and chess players.

Dividend growth stocks are usually considered to be boring, "defensive" investments. But I want to present them in a different light: As truly extraordinary investment opportunities that are outliers in the same sense as in the definition above. Their achievements fall outside of the normal performance of stocks generally.

There are 15,705 stocks in the Morningstar database. You can see that number near the upper left corner of this screenshot that I chose randomly from a list of all of the stocks that Morningstar covers:

(click to enlarge)

The dividend yield of each stock is shown at the far right. Most of them yield 0.0%. That is, they do not pay a dividend. If you use the Morningstar screener to select stocks with yields greater than zero, you find that there are 2,974 in the database:

(click to enlarge)

So only about 19% of stocks pay a dividend at all.

Most dividend growth investors demand more than mere payment of a dividend, they are looking for a minimum yield. Let's trim the list to those yielding 2.5% or more:

(click to enlarge)

That reduces the list to 1307, less than half of all dividend payers. We're down to 8 percent of the original 15,705 - not in "elite" status yet, but getting closer to it.

Dividend growth investors require not just a reasonable dividend yield, but dividend growth as well. How many of these stocks have a 5-year annualized dividend growth rate (DGR) of 4 percent or more?

(click to enlarge)

The answer is 888. But if we require both the minimum dividend yield of 2.5% and the growth rate of 4% per year at the same time, the qualifiers shrink to 357. We have cut the list by more than half again, and now we have just 2.3 percent of the original population.

Let's keep excavating. I won't purchase a dividend growth stock that is more than fairly valued. I use two tools to check valuation: Morningstar's star ratings (which are a reflection of how their analysts view a stock's current price to fair value ratio) and Chuck Carnevale's FASTGraphs. My experience is that the two sources are in agreement a great deal of the time, but that both can be used as a check on the other. Morningstar's analysts only rate about 2000 stocks or fewer, but my experience is that they rate over 90% of the very best dividend growth stocks. Let's use Morningstar's screener to screen for their star ratings:

(click to enlarge)

Now we are down to 117 stocks. Again, we cut the list by more than half, and we are down to just 0.7% of the original universe.

We are getting close to a level that might be called "elite." In sports, the most elite players can be found in the professional ranks. Here are statistics from the NCAA on how many high school athletes get drafted into the pros:

(click to enlarge)

To reach that level of "eliteness," we would need to cut our stocks by about another order of magnitude. And in fact, many dividend growth investors either screen for or score a variety of other factors. For example, in my research for my annual Top 40 Dividend Growth Stocks, I look at factors including:

  • Number of years of consecutive annual dividend increases
  • ROE
  • D/E ratio
  • Credit rating

I also examine each company's business model and competitive situation. Additional factors examined by many dividend growth investors include DGR trends, earnings trends, profit margins, payout ratios, and a host of others.

The point is, the best dividend growth stocks are quite uncommon creatures. While many of them are well-known as companies or brands, such as Chevron (NYSE:CVX), McDonald's (NYSE:MCD), and Raytheon (NYSE:RTN), I think that many investors fail to appreciate just how special they are as investments. It takes a truly elite company to be able to pay and raise a dividend for 5 years in a row, let alone 30 or 40 years.

If you are on the lookout for a growing income stream to reinvest or to live off, stocks like these are anything but boring. They are sexy and way cool.

Postscripts:

1. The 5-year DGR screen above does not tell you whether the dividend has been increased annually without interruption. That information and a whole lot more is available in David Fish's Dividend Champions document, which I consider to be the best first source for identifying great dividend growth stocks. Without regard to yield or DGR, the latest update of that document shows that 105 stocks have increased their dividends for 25 straight years or more (Champions), 201 have 10-24 year streaks (Contenders), and 164 have 5-9 year streaks (Challengers).

2. All screens - in fact, all data - is based on past performance. That does not guarantee anything about the future. But it often provides clues when interpreted sensibly.

Disclosure: I am long CVX, MCD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Dividend Growth Stocks Are Success Outliers