A recent article by SA contributor Mr. Nelson Smith caught our attention and perhaps the attention of a lot of Dividend Growth Investors [DGI] on Seeking Alpha. The comments section in that article is an evidence of it.
Mr. Smith's main argument is that investors might be over paying for dividend growth giants like Coca-Cola (NYSE:KO), McDonald's (NYSE:MCD), Johnson & Johnson (NYSE:JNJ) and that dividend growth investors should look beyond these well known names. Sure, there is nothing wrong with diversification but why would so many investors stick with these companies through good times and bad? We present a few reasons below, with all due respect to Mr. Smith and his article. Let us get into the details.
Portfolio Volatility: One of the main reasons dividend growth investors tend to stick with a few well known companies is the steadiness that these companies offer. Sure, one can always look back at periods like 2009 and say no company is safe. But you need to have your money invested somewhere (unless you want to play the riskier game of timing the market each time).
The stocks that Mr. Smith presented are in the first table below. They have an average beta of 0.60, which is not bad at all. But if you look at the second table consisting of some very well known dividend growth stocks, the beta is even better at 0.38. The table excludes Microsoft (NASDAQ:MSFT) and Aflac (NYSE:AFL) because those two companies do not have the same pedigree that the rest of the stocks have in terms of dividend growth. Just for the record, even if MSFT and AFL are included, the beta of this portfolio would still be lesser at 0.50.
Reliability: Hang on a minute before you dismiss this as being the same as the last point about volatility. This reliability factor is about these companies and their dividend growth streaks. The table below should seal the discussion in favor of the dividend growth stalwarts.
Verizon (NYSE:VZ) is not yet considered by many as a signature dividend growth stock and rightly so. But if you exclude Verizon, the other 7 companies have been increasing dividends for more than 3 decades at least. Why is this important? Two reasons:
- The longer the streak, the greater the company's commitment to shareholders.
- The longer the streak, the greater the chances that the company is almost immune to the economic conditions. In the last 25 years, we've been through three market meltdowns: the 1987 crash, the 2000 tech bubble, and the 2009 financial crisis. Yet, none of these companies slashed or eliminated dividends. To top it all, each one of them have been increasing dividends through good times and bad.
Stocks like EPB that Mr. Smith has mentioned have been paying dividends since 2008. ETR, for example, has paid the same dividend for the last 3 years. There is no "G" in the DGI in such stocks. Enough said.
Staples: Mr. Smith also pointed that Staples like Coke, McDonald's and Altria (NYSE:MO) are heavily favored by dividend growth investors. As Mr. Smith himself mentioned in his article, these are companies that churn out products that are highly unlikely to go out of the fashion. Because there is nothing fashionable about them in the first place!. The same cannot be said about the Myspaces, Boo.Coms, and Lehman Brothers of the world.
Wharton Professor Mr. Jeremy Siegel performed exhaustive study of the performances of various stocks and sectors over a 50 year period. His conclusion was that Consumer staples and Healthcare stocks outperformed the market as well as other sectors.
Diversification: Who says there cannot be a diversified portfolio of dividend growth stocks? Here is an attempt. Coke is an international beverage company, McDonald's operates restaurants throughout the world, Altria sells tobacco in the U.S, JNJ is a Healthcare company, Exxon is an Oil and Gas company. If you want to go international, try Glaxo (NYSE:GSK) or if you want U.S companies that solely sells abroad, try Philip Morris (NYSE:PM). The point is, there are so many dividend growth stocks from various sectors/industries/countries.
Dangers of High Yield: Buying the highest yielding stock might look like a no brainer. Who doesn't want more for their investments? But there is a difference between a yield level that is worked up higher like a step ladder versus one that looks so scary already that it might topple anytime.
Telecom is a space where there are a lot of high yielding stocks like AT&T (NYSE:T) and Verizon. If you think those two are high yielders, check out CenturyLink (NYSE:CTL), Windstream (NASDAQ:WIN), and Frontier Communications (NASDAQ:FTR). Which set of companies attracts you? The dividend growth ones (T and VZ) or the high yielders? Check this piece out if you are not sure.
Bonus Point #1: None of the "usual" dividend growth stocks mentioned in this article pay out more than they earn aka payout ratio.
Bonus Point #2: We've mentioned this in other articles but this is worth repeating. There is a reason Coke and Altria (examples) are not yielding over 10% right now, in spite of their impressive dividend growth each year. The share price almost always catches up with the yield. Find that hard to believe? Coke yielded above 4% just once in the last 5 years and that was during the 2009 turmoil. Why is that? (Rhetorical question).
Conclusion: No size fits all. Similarly, no investing strategy works for all. Some invest for income replacement, some buy and sell for the thrill of it. Oddly, dividend growth investing gets a lot of flak more than any other type of investing here on Seeking Alpha (options or growth or value). Or maybe it's not too odd because success attracts detractors. With that, we rest the case of continuing with the dividend growth stalwarts. The judgment is yours.