Editors' Note, January 22, 2016: The author has revised the table since its original publication.
Dividend growth investing is a long-term strategy but the poor performance of the market is creating doubt in the mind of new investors. If you started dividend growth investing in the last two years or so, you may be wondering if it's still worth it to pursue this strategy.
Since the first trading day of 2015, the S&P 500 is down almost 10 percent so odds are high that your portfolio has underperformed a basic savings account, especially if you were overweight on energy or basic materials stocks. The increasingly bearish environment is not a pleasant situation as it can feel as if all your work has been for nothing.
Time in the market vs. timing the market
If you're a great market timer, this article isn't for you, but I know myself and I'm terrible at timing the market. I believe time in the market trumps timing the market, an adage that seems to ring true as most individual investors and even professionals consistently underperform the market. Similarly, a performance review of Fidelity accounts revealed that the customers with the best performance were typically either dead or inactive.
At challenging times like these, it can be valuable to zoom out to focus on the big picture. Everyone's strategy is a bit different, but in my eyes dividend growth investing is largely about buying high-quality companies with staying power and excellent cash flow generation. In my case, I want to build a diversified portfolio filled with companies that have a good chance of increasing dividends for many decades to come.
Market corrections can be unsettling but it is important to stay the course despite all the short-term noise. Past performance is no guarantee of future results, but it can be very valuable to study historical market returns to familiarize yourself with possible outcomes. It can be unnerving to see your portfolio value fall below your principal investment, but at times like these it pays to stick to your plan.
If you're still in the accumulation phase, it's important to remember that market corrections can accelerate your future returns. A lower entry price allows you to buy more shares, which results in higher future dividend income. It is impossible to predict what the market will throw at you over the coming months/years, but it's a comfortable thought that a portfolio of quality blue chip stocks is likely to yield more dividend income year after year.
A Johnson & Johnson dividend growth investing case study
To illustrate why it's important to stick to your strategy and not give in to market noise, I'm going to provide a case study of a historical return achieved by a typical high-quality dividend growth stock.
Image source: Johnson & Johnson
In this article, I'm taking a look at the portfolio of James, a fictitious man who started investing in 1996 when he was 30 years old. James got a job at Johnson & Johnson (NYSE:JNJ) in the early 1990s and was so impressed by the company's operation that he decided to invest a piece of his paycheck in the company's shares.
One important note here is that investing in a single company goes against common investment wisdom as it exposes you to significant company and sector-level risk but the results of this case study are in line with the performance of other popular DGI stocks like Unilever (NYSE:UN) (NYSE:UL), PepsiCo. (NYSE:PEP), Exxon Mobil (NYSE:XOM), P&G (NYSE:PG), etc. Stocks like Coca-Cola (NYSE:KO) and General Electric (NYSE:GE) performed worse, while others like Colgate-Palmolive (NYSE:CL) and the old Philip Morris (NYSE:PM) performed better.
In early 1996, Johnson & Johnson was regarded as a solid blue chip performer, the company had solid earnings growth expectations and was trading at 22.65 times last year's earnings.
We'll assume James started his portfolio with a $1,000 investment on the first trading day of 1996. He saved $1,000 a month for the next 20 years and pooled his fresh cash together with Johnson & Johnson's dividend to make a single investment per quarter on the dividend payout date. To keep things simple, the calculation uses fractional shares and transaction costs were left out of the picture as there's no typical rate.
|JNJ dividend growth portfolio case study (split-adjusted data)|
|Stock price||Shares||Quarterly investment||Dividend per share||Forward quarterly dividend income||Market value|
Throughout his investing career, James was often tempted to call it quits but fortunately he persevered. This was not easy as he encountered a lot of minor setbacks over the last two decades, as well as more major panics, including the Asian financial crisis in 1997, the Russian financial crisis in 1998, the collapse of the Dot-com bubble in 2000, the aftermath of the September 11 attacks, the stock market downturn of 2002, the financial crisis of 2007-2009, the European sovereign debt crisis, the 2010 Flash Crash and the current weak global economic environment.
Besides market risk, James also faced company-specific risk in the form of patent infringement claims, penalties for illegal marketing, and the string of Johnson & Johnson product recalls in 2010.
But despite all of this, the $1,000 a month set aside by James compounded at an impressive rate. James invested a grand total of $241,000 (plus his dividends) and is now sitting on 6,221 shares of Johnson & Johnson. These shares are now worth $607,497.06 and entitle James to an annual dividend of $18,663.50, a yield on cost of 7.75 percent.
The chart below tracks the evolution of the portfolio value since 1996. Due to the use of quarterly data, some of the peaks and lows are filtered out but it's quite surprising how small of a blip the financial crisis already is. The $241,000 ($1,000 + $1,000 a month for 20 years) is now worth over $607,000.
Dividend growth investing is a long-term strategy; in the beginning, the dividend payouts are relatively small and it's easy to lose focus. At the end of 1996, the forward dividend income of James was just $202.98, hardly something to get excited about.
It really takes a decade or so to really get the ball rolling, afterwards it turns into a real avalanche of dividends. Towards the end of 2006, the forward dividend income of the portfolio exceeded $5,000, and today, James is looking forward to a yearly dividend income in excess of $19,000 (after factoring in next quarter's dividend increase).
Markets go up and down but as a dividend growth investor, it's important to stay the course. Past performance is no guarantee for future returns, but I believe making monthly investments in quality dividend-paying stocks is a prudent investing strategy. It's easy to get lost in the day-to-day market noise, but as an accumulator, it's important to stick to your strategy. Dividend growth investing requires patience, and if you can stay in the market for the long haul, you will likely be well rewarded.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.