Let's cut to the chase. I am not here to waste your time. The major points of this article are…
- Companies are increasing their dividends at the fastest pace in 35 years and are expected to continue.
- In you have been investing in S&P indices over the last 2 years, then you have been dividend growth investing.
- Can dividend growth investors apply the same principles that they use in stock picking to value and subsequently invest in index funds?
In my first article here on SA, I asked whether dividends were becoming too popular. A lot has transpired since then and the market has seemed to go straight up in a "risk on" manner. During this time, the utilities sector and some of our other dividend payers have underperformed.
However, I believe that things like our national debt, student loan bubble, and housing troubles- not to mention the mess in Europe- will continue to weigh down our recovery. Therefore, my thesis has been that dividends, and the companies who pay them, will remain popular for the next couple of years. I think companies are listening to their shareholders' desire for that "bird in the hand" of which we often speak.
Dividend Growth Indexing
A few years ago, a friend of mine has asked for help with investing in regards to her company-sponsored 401k. She had access to a number of high cost funds that have underperformed the market and a bunch of low cost indices; it was easy to pick the low cost funds that matched the S&P 500, small-cap, and mid-cap indices. The other day, after reviewing her portfolio, I stumbled across this press release by S&P.
S&P announced that…
- Dividend increases were $50.2 billion in 2011. This was an 89.2% increase from 2010.
- Historically, payout rates have been around 52%, but are "near their lows at under 30%."
- They expect, due to strong cash-flow and cash reserves, to see record dividend payments in 2012.
Then it occurred to me: My friend is taking part in dividend growth investing!
Reasons to Index
More experienced investors will know all of the arguments in favor of indexing, but it is always a good idea to review and apply to current assumptions and actions.
- When you include costs, 50-80% of fund managers underperform the index (depending on the year).
- With indexing, you don't have to worry about beating the market because you "are" the market.
- Diversification, which provides a measure of safety.
(Note: Most often, indexing goes hand in hand with dollar cost averaging)
Remember, in an index like the S&P 500, you still get ownership of companies like Procter and Gamble (NYSE:PG), Coca Cola (NYSE:KO), Abbot Labs (NYSE:ABT), Intel (NASDAQ:INTC), etc., but it also gives you the opportunity to grab a piece of Apple (NASDAQ:AAPL), a company that I haven't felt comfortable enough to own outright.
"But Indexing Doesn't Work…"
I can hear some readers shouting: "Indexing doesn't work; the S&P 500 has had poor returns over the past 13 years!" I think this is a valid point; however, I began to wonder as I was writing this: Can some of the same principles used in dividend growth investing be applied to indexing?
- In regards to entry points: Buy when the market is undervalued or its dividend yield has reached a certain target, etc.
- In regards to selling: Sell when it becomes too overvalued or a certain percentage of companies cut their dividend, etc.
Perhaps actions like this would have helped you to buy low and sell high during peak periods of fear or greed. Some may argue that this defeats the purpose of indexing, but, for those who have left indexing for dividend growth investing, I think it might be an idea worth considering.
As S&P noted, companies have plenty of room to increase their dividends; I think this will happen as they respond to the wishes of their shareholders, who are asking for higher payouts, in this ZIRP world in which we live. So, perhaps for the next few years, one of the safest ways to be a dividend growth investor is by indexing. Can dividend growth investing principles be used to determine when to buy or sell indices? Maybe, but I think that is a bigger discussion for another article.
Additional disclosure: As always, this is my own opinion; do your own due diligence.