Stocks That Raise Dividends Outperform

Stocks with rising dividends can also lift your overall stock investing returns, whether your portfolio is aiming for dividend income or not.

Early this year BusinessWeek cited Ned Davis research showing that stocks with at least five years of dividend growth outperformed the S&P 500 every year from 1972 to 2008. This is a strong argument for considering these types of stocks in a portfolio, considering all the different economic conditions, market cycles and sector rotations that occurred during this 36-year time period.

Two other points about the research results: first, the difference in performance wasn’t trivial. According to the data, companies with at least five-year dividend-growth records clocked average yearly gains of 8.9%, compared with 6.2% for the Standard & Poor's 500.

Second, the outperformance was surely due to dividend growth, not simply the presence of a dividend. Companies that paid relatively steady dividends gained 6.3% annually, a fine showing compared to the index, but nothing like what the dividend-growers racked up.

Clear thinking will tell you this type of performance shouldn’t be expected to repeat itself time-period after time-period, but I don’t think the results are purely coincidental. Continuing to pay out more and more cash to shareholders every year takes a healthy company with disciplined management and a solid business model. So it’s certainly credible that those types of companies’ stocks could outrun the pack over time.

For investors who don’t want to pick individual stocks and stock-pickers who don’t want to load up their portfolios with individual dividend-stock positions, a good choice to look into is the Vanguard Dividend Appreciation ETF (VIG). VIG holds a custom index it calls the Dividend Achievers “Select” Index, which is a subset of the well-known Mergent Dividend Achievers Index, composed of stocks with at least a 10-year record of dividend increases.

To get their subset, the VIG index goes beyond the baseline 10-year Mergent criterion by running balance-sheet and profitability screens that ‘winnow in’ Dividend Achievers with good financial health and seemingly good prospects.

And it seems to work: Morningstar analysts recently noted that almost all VIG’s holdings are either “wide-moat” or “narrow-moat” companies, the Morningstar shorthand for companies with sustainable competitive advantages.

And, compared to some other popular dividend-growth ETFs, VIG has worked for investors as well. Since its inception in 2006, its well-diversified portfolio has outperformed other popular dividend-growth ETFs, sometimes startlingly so.

For example, VIG outperformed the PowerShares Dividend Achievers Portfolio ETF (PFM). This ETF holds the broad universe of Dividend Achievers that VIG uses as raw material for its “Select” screening. But VIG charges less than half the expense ratio of PFM, in essence adding value for half price, while PFM investors pay double the VIG fees to get ‘the bad and the ugly’ along with the ‘good.’

VIG also outperformed the SPDR S&P Dividend ETF (SDY), which is based on the High Yield Dividend Aristocrats Index, not the full Aristocrats list; as well as the Dow Jones Select Dividend Index (DVY), another collection of high yielders. And did so with a lower expense ratio.

VIG’s outperforming these two, both in terms of better price appreciation and fewer portfolio dividend blow-ups, might reheat some old meatloaf about dividend investing in general: quality, diversification and growth are in many instances better portfolio ingredients than concentrated high yield. Even VIG’s own high-yield cousin, the Vanguard High Dividend Yield Index ETF (VYM) hasn’t distinguished itself from the rest of the yield-stretching crowd.

And VIG has been coming through fairly well in a tough dividend environment. It paid out nearly 18% higher dividends in 2008 than 2007. Early indications from Vanguard are that VIG’s Q3 2009 dividend will be slightly lower than in 2008, resulting in an overall 2% decline YTD vs. the first three quarters of 2008.

Other ETFs’ dividends are seeing much harder times than VIG. For example, “Aristocrat” SDY’s year-to-date dividend payments seem to have stabilized about 20% lower than the same period last year. Aristocrats? With aristocrats like these, SDY investors should be pining for the French Revolution; instead of “let them eat cake,” it’s been “let them hold a bake sale” to make up for the deep cuts.

Additionally, apropos of the Ned Davis research, since its inception VIG has also outpaced the S&P 500. The other ETFs roughly tracked the market over that time period, except DVY, which lagged it.

Like any investment, VIG is not for everyone, and I profile it here as much to illustrate its successful style of dividend-growth investing as to single it out as a specific investment choice.

Blue-chip investors who prefer owning individual stocks, for example, may find they already own such VIG top holdings as IBM (IBM), Johnson and Johnson (JNJ) Coca Cola (KO), McDonalds (MCD), Walmart (WMT), or others. And hard-core high-yield fans will no doubt sniff at VIG’s yield, less than 2.5%. Still, stock-pickers could do a lot worse than simply browse VIG’s 180+ holdings as a starting place for consistent, high quality dividend-growth ideas.

Finally, for analyses of four low-yielding dividend-growers that have beaten their benchmarks, you can check out my Seeking Alpha articles “With a Name Like Becton Dickinson . . .” (BDX) and “Three Midcap Tech Stocks With Rising Dividends” (FDS), (HRS) and (JKHY).

References and Links

BusinessWeek summary of Ned Davis research, in “Follow the Juicy Dividends” February 12, 2009.

Vanguard Dividend Appreciation. For other ETFs, follow the link then enter the ticker.

Vanguard Dividend Appreciation, list of all holdings.

Morningstar, “Where Our ETF Team Is Finding Opportunities” August 20, 2009.

Seeking Alpha, “With a Name Like Becton Dickinson . . .” September 17, 2009.

Seeking Alpha, “Three Midcap Tech Stocks With Rising Dividends” August 24, 2009.

Disclosure: Long a number of stocks with rising dividends, including BDX, FDS, HRS, JKHY, JNJ, KO, WMT.

Comments

[Senan:]

+1 for investing in dividend stock. I think especially in the volatile times we live in at the moment, dividends (and growing dividends in particular) will provide the amateur investor with some comfort.

Sep 23 03:44 AM

[Low Sweat I...:]

Thank you for your comment, and for making the point that stocks with growing dividends are often a good choice for novice investors.

As an addendum to the article: Vanguard has announced a Q3 2009 dividend that is flat with Q2 ’09, and lower than expected vs. Q2 ’08. This resulted in a 4% YTD dividend reduction, compared to the 2% decline estimated in the article.

The estimate in the article was based on a pre-announcement phone call to a Vanguard representative, who provided a published Bloomberg estimate.

On Sep 23 03:44 AM Senan wrote:

> +1 for investing in dividend stock. I think especially in the volatile
> times we live in at the moment, dividends (and growing dividends
> in particular) will provide the amateur investor with some comfort.

Sep 23 07:20 PM

[E Nuff Sed:]

Great post. Rising dividend stocks should also provide a hedge against inflation if that becomes a problem in the years to come.

Oct 19 09:07 PM

[Low Sweat I...:]

Thanks for your comment.

I like your point about dividend growth and inflation. I’m hearing a lot lately about TIPS, and of course gold. Dividend increases deserve more credit than they are getting as a straightforward way to offset price increases.

On Oct 19 09:07 PM E Nuff Sed wrote:

> Great post. Rising dividend stocks should also provide a hedge against
> inflation if that becomes a problem in the years to come.

Oct 20 02:25 PM