Dividend-growth investing is not widely recognized in the established retirement industry. Typically Registered Investment Advisors (RIAs) focus on:
- Maximizing capital (“The Number”) until shortly before retirement.
- Adjusting the portfolio to make it “safer” as retirement approaches. This invariably means substituting bonds for stocks. Further adjustments may be made as the years go by to further reduce stock allocations, which are considered riskier assets by their very nature.
- Embarking on a “distribution” or “retirement withdrawal” strategy. The typical approach for that phase is to withdraw 4% of your Number in the first year of retirement, then increment the withdrawal amount 3% each year to account for inflation.
Then off you go into a slow-motion race to the bottom, to see which kicks the bucket first: You or your portfolio. Monte Carlo studies are often used to show how long a portfolio of particular asset allocations and size will last. These studies utilize historical rates of return—and the historical variability of those returns—for the different asset classes. The Monte Carlo studies combine thousands of permutations of outcomes to estimate the percentage of success in having your portfolio last a given number of years.
With the help of reader suggestions, I located a few RIAs that see things differently. These firms not only accommodate some degree of dividend-growth investing in a customized portfolio, but they actually stake their businesses and reputations primarily on the dividend-growth strategy.
I thought it would be instructive to see not only how they justify that, but also to see how they do it. The following are presented in alphabetical order. In no way are these summaries meant to be endorsements of the firms. All of the following information is from the firms’ websites, each of which is linked within its write-up so you can have a look for yourself.
Deschaine & Company (Illinois/ St. Louis Metro area)
Deschaine & Company specializes in managing dividend-focused equity portfolios for investors seeking current and future income. The firm believes that the conventional goal of growing principal gives the average investor the least likely chance of achieving his or her retirement objectives.
Deschaine recognizes that reaching a Number is only half the battle. Converting assets to provide retirement income at some point in the future is difficult. It requires the prediction of factors that are out of the investor's control, including stock market performance, interest rates, and future portfolio values.
I particularly liked this table comparing a capital-centric mindset to an income-oriented one:
Conventional Thought Process
Deschaine’s Thought Process
What's my current account balance?
How much income does my portfolio generate?
How much is my account up / down this year?
How much did my income grow this year?
I bought XYZ at $20 hoping to sell it at $30
We are going to buy XYZ at $20 for its 5% current yield
XYZ is down to $10, I see no alternative but to sell it at a loss
XYZ is down to $10, but the dividend is intact, so we can buy more shares at $10 locking in a healthy 10% yield
To retire, I'll have to grow my portfolio to X, then convert it to income producing assets and live off the income at retirement
We invest the portfolio for income and income growth so one can retire and live from the compounded dividends and income
Deschaine has a “main” portfolio called the Equity Income Portfolio. To select stocks, the firm uses the following criteria:
- Yield > 3%
- Stock must show 1-, 3- and 5-year positive dividend growth
- Stock must have “attractive valuation” and “positive and consistent earnings growth”
- Stocks whose current dividend yield is above its 5-year average are preferred
According to the website, the result of those screens is 30-60 stocks. Deschaine will overweight industries or sectors “subject to usual portfolio risk controls and client portfolio construction.” Their current Equity Income Portfolio has 72 stocks and one ETF (an MLP fund, although the portfolio also includes individual MLPs). I recognized 18 past or present Top 40 Dividend Growth Stocks among its holdings.
Deschaine calls its strategy “buying high and selling low.” What they refer to, of course, is the dividend, not the price. “Buying high” describes purchasing a stock whose current dividend is greater than its 5-year average. The firm considers a stock a hold as long as it maintains its current dividend. A stock is sold if it cuts its dividend for any reason, or if the current yield drops one standard deviation below the stock’s five-year moving average yield.
The firm issues a quarterly 8-page newsletter, back copies of which are available (all the way back to 2002) on its website. The newsletters and the site itself contain fairly extensive descriptions of studies and projections that the firm has done. Representative titles of the lead articles in recent newsletters include “Dividend Growth Investing: It's about Capturing Compounding” and “Do Stock Investors Earn More from Capital Gains or Dividends?” The stocks currently in the Equity Growth Portfolio are listed in the newsletter, along with each one’s current price, current yield, and yield on cost.
Dividend Growth Advisors (Indianapolis, IN)
From Dividend Growth Advisors’ (DGA) home page: “We believe that dividends are the best indicator of the future price performance of a stock. Our reasoning is straightforward: dividends are paid when there are attractive earnings. When dividends are paid consistently at an increasing rate over the long term, it follows that this is likely to exert a positive movement [on] price performance.”
DGA focuses more heavily on dividend growth than the other firms. They state that “…consistent earnings growth drives consistent dividend growth. Earnings provide the ability to pay and grow dividends. Over the long run, consistent earnings have had a positive influence on the price performance of a stock. This is why we begin with companies that have well-established records of consistent earnings and dividend growth.”
DGA describes its stock selection criteria as including these factors:
- The 10/10 Test: Consistently pays dividends at increasing rate that averages at least 10% per year and pays those dividends for a minimum of 10 consecutive years. In excess of 100 companies pass this initial hurdle.
- Is committed to distributing profits to shareholders.
- Produces essential products and services that we need to live, such as water, food, energy and healthcare.
- Is an industry leader, with strong brands and growing global exposure.
- Demonstrates an ability to manage their business with consistent earnings growth in various economic cycles.
- Has a record of steady results, strong cultures, and shareholder-friendly managements.
DGA says that a company must continue to pass the 10/10 Test to remain in its portfolios. If a stock’s trailing dividend growth rate dips below 10%, DGA eliminates it from their clients’ portfolios.
DGA customizes portfolios to meet client objectives and preferences, but the dividend growth strategy drives stock selection. Each equity portfolio holds 25 – 30 dividend growth stocks across industries, sectors, and cap sizes. The firm is “sensitive to diversification considerations” but does not consider itself bound by particular sector weightings. Portfolio turnover is described as “generally low” at one point on the site and as 25% at another point.
DGA sells when the firm thinks fundamentals are likely to deteriorate; valuations are excessive; they have a better investment opportunity; or a stock no longer passes the 10/10 Test.
On the day I accessed it, the website listed the top 11 holdings as of March 31. Dividend increase streaks ranged from 10-36 years, and 10-year average annual increases ranged from 10.6% to 29.7%. With the emphasis on dividend growth rates, I expected to find some stocks with yields that many dividend-growth investors would consider low, and I found 7: Novo-Nordisk [(NYSE:NVO) 1.1%]; TEVA Pharmaceutical [(NYSE:TEVA) 1.8%]; Archer-Daniels Midland [(NYSE:ADM) 1.7%]; International Business Machines [(NYSE:IBM) 1.7%]; Walgreen [(NYSE:WAG) 1.7%]; Cardinal Health [(NYSE:CAH) 1.8%]; and Praxair [(NYSE:PX) 1.9%]. The site does not list these yields, but it does list the 10-year dividend growth rates. Clearly, DGA emphasizes dividend growth rates over dividend yields as the core of its strategy.
Martin Capital Partners (Eugene, Oregon)
Martin describes itself as an independent investment advisory firm specializing in the management of dividend growth portfolios for private and institutional clients. The firm states that they are dividend growth investors, and that “we believe that a portfolio focused on high quality companies with a history of dividend payment and dividend growth will result in above average returns over time, with reduced volatility.”
I liked this quote from Warren Buffett, which Martin displays on its home page: “The market serves as a relocation center at which money is moved from the active to the patient.”
Martin states that the contribution of dividend income to total return is “profoundly significant,” and that the longer the time horizon the more dominant is its impact. “Though stock prices fluctuate, dividends are tangible and constantly positive, and over the course of time increases in dividends induce increases in the prices of the companies generating those dividends... Due to the mathematics of compounding, large losses have a disproportionate effect on cumulative returns. We attempt to avoid this…by de-emphasizing short-term results, which can inadvertently lead to accepting additional risk. Through the positive compounding effects of dividend payment and dividend growth, we help our clients achieve investment returns consistent with their goals, without undue risk.”
Unfortunately, specific stock selection techniques are not shown on the website. Only general factors are listed, such as flexible, multi-disciplinary process; emphasis on fundamental security analysis; primary focus on identifying quality companies exhibiting exceptional financial strength and providing durable dividend yields. But the website does provide some specifics as to the resulting portfolios: They are comprised predominantly of domestic and international large cap stocks, although the firm’s strategy retains flexibility to alter exposure to growth and value styles as well as to mid-size and small-cap companies. The firm targets a portfolio of roughly 35 securities, collectively producing a dividend yield and a dividend growth rate exceeding that of the S&P 500 (NYSEARCA:SPY) Index.
In reading Martin’s newsletter dated April 15, it was clear that the firm expects significant inflation, and it compared current conditions to the 1970’s for clues as to what will be important for equity investors in an inflationary cycle. The article noted that market price rose 17.3% in the 1970s, but when dividends and dividend growth were included, the total return was almost 77%, with dividends contributing over 70% of that. Stating that dividends will “…remain crucially important in the next cycle as well,” the article noted: “Companies with established dividend cultures, and particularly cultures of growing their dividends, generally have the financial strength to withstand temporary margin compression that comes in the early stages of inflation.….In an inflationary environment with rising interest rates it will be difficult to get much, if any, multiple expansion (rising P/E’s). The burden of total return will fall on dividends and earnings. As was displayed in the 1970’s, a focus on dividends was extremely important to capturing the bulk of total return.”
Additional material on the firm’s website includes the two most recent quarterly newsletters. The firm does not display its stock picks nor any particular portfolio.
Miller/Howard Investments (Woodstock, NY)
Miller/Howard (MH) has the name recognition of Lowell Miller, author of The Single Best Investment: Creating Wealth with Dividend Growth.
MH’s investment philosophy is based on this formula: HIGH QUALITY + HIGH YIELD + GROWTH OF YIELD = HIGH TOTAL RETURN. Its investment approach will sound familiar to dividend-growth investors: The firm “…believes that financially strong companies with rising dividends offer investors the most consistent performance as well as the highest added value....[O]ver the long-term, dividend-paying stocks outperform non-dividend paying stocks, and companies that increase their dividends perform the best. We strive to generate returns for our clients that rise steadily, without excessive volatility, in any market environment.” They make the interesting point that dividend growth is “a better ‘analyst’ than analysts: Dividend[s] and dividend increases…are one of the best signals from management about the current and future prospects for a company.”
MH points out that dividends are always positive, and it contends that “increases in dividends induce increases in the price of the equity generating those dividends.” In other words, it sees a causal relationship between dividend increases and stock prices, not just a correlated relationship.
The firm offers 7 strategies built around various flavors of dividend investing. The Income-Equity Strategy is the oldest (1997) and first-listed, and a great deal of information is provided about it, so I am going to treat it as the basic strategy to illustrate this firm.
MH’s “un-fixed income” Income-Equity Strategy is a dividend-growth portfolio that seeks to provide high current income, growth of income, and growth of principal as conservatively as possible (lower volatility) while investing in equity markets. Its stocks are primarily U.S. based, multi-cap companies with “consistent and reliable business models and a history of high and rising dividends that we project will continue to grow.” Stock selection focuses on essential services, low-cost producers, niche companies, and companies with outstanding consistency in earnings and dividends. MH will sell a stock when:
- The company fails to increase dividends with no reasonable excuse.
- There is deterioration in a company's fundamentals
- The stock exhibits extended overvaluation
- There is a negative impact from a regulatory decision.
- MH needs to make room for a more attractive investment.
Up to 25% of the portfolio can be invested in foreign stocks that trade on U.S. exchanges (ADRs), and up to 25% can be MLPs. In fact at the current time, the portfolio holds (by weight) 21% foreign companies, 19% MLPs, and 6% REITs among its 42 total holdings.
This passage is worth repeating in its entirety:
We have found that financially strong companies with rising dividends offer the most consistent performance as well as the highest added value. Over time, it is compounding income — not style, sector, or asset allocation — that's the main driver of long-term returns. Many studies, including our own, show that dividend-paying stocks have historically outperformed non-dividend-paying stocks, and companies that increase their dividends tend to perform the best. Stock prices may fluctuate, but dividends, when paid, are always positive. Over time, increases in dividends will likely induce increases in the price of the equity generating those dividends. Studies have also shown that dividend increases are the best signal from corporate management regarding the future prospects of a company.
Other portfolios include a no-MLP version of Income-Equity; High Yield (9th Decile); an all-MLP portfolio; and Rising Dividend Plus that uses technical and momentum considerations. All portfolios are described in detail via fact sheets. Ongoing performance is reported in quarterly reviews, with four past issues available. The firm also sub-advises three income-oriented mutual funds.
Miller/Howard’s website has a wealth of research materials. There are reports on basic research from others, the firm’s own research, articles from national media, white papers, and videos, all of which, in one way or another, reinforce the benefits of dividend-growth investing. For example, two of the videos are titled, “Are Dividend-Paying Stocks Better than Tenants?” and “Retirement: Will My Money Last as Long as I Do?” The latter video is very effective, with an illustration of the difference (between 2000 and 2009) of making 5% + inflation withdrawals from a $1 M S&P 500 portfolio as compared to owning a $1 M dividend portfolio that yielded 5%. At the end of the 10 years, the total-return-withdrawal portfolio’s value is $555,900. The dividend portfolio’s value is $889,630.
In this table, “DGR” means dividend growth rate. If a cell is blank, that means that I could not find the answer or information on the website.
Deschaine & Company
Dividend Growth Advisors
Martin Capital Partners
Typical or Actual Portfolio Size
Not stated, but holds stocks with current yield as low as 1.1%
Minimum Dividend Increase Streak
Minimum Dividend Increase Amount
Positive 1-, 3-, and 5-year DGR
10% trailing 10-year DGR
Sell if Stock Cuts its Dividend?
Yes, or if stock fails to increase dividend with no reasonable excuse
Sell if Stock’s Yield Falls Below Certain Threshold or Valuation Becomes Excessive?
Sell if Stock’s 10-Year DGR Drops Below 10%?
Target or Actual Dividend Return for Portfolio
Yield and DGR exceed S&P 500
Include REITs and/or MLPs?
Typical Annual Turnover