Most of the time, we talk about what needs to happen for our investments to succeed. If we buy shares of Apple (AAPL), we often think of how many iPhones and iPads the company will have to sell the next quarter to build on its streak of rapid earnings growth. Likewise, when we buy shares of General Electric (GE), we often talk about how GE Capital will be able to pay significant dividends to the parent company and industrial growth abroad will fuel the company's future growth in a manner consistent with its storied reputation. This makes sense-for most of us, the purpose of investing is to delay gratification so that we can have more money (and hopefully more purchasing power) that our future selves may enjoy.
But with every investment that we make, we are also choosing the terms on which we might fail. Sometimes, this possibility of failure can be quite obvious. If you bought shares of Bank of America (BAC) during the financial crisis, part of your failure statement might be: "If the Countrywide purchase spirals further out of control, it might sink the entire company." Likewise, if you bought Research in Motion (RIMM) in the past couple years, your failure statement might be: "If Apple successfully takes away market share from the Blackberry, severe earnings deterioration might soon follow, thereby putting the entire company at risk."
When I think about investing in these terms, I can't help but feel inclined to favor dividend growth investing in companies that have impressively long records of rewarding shareholders. For most of us, the money we invest represents some dream we have-whether it be retirement, financial independence, the ability to attend every game of the Stanley Cup, spend a couple months touring through Europe, or whatever it may be. That's when the neon signs of Coca-Cola (KO), Exxon Mobil (XOM), Johnson & Johnson (JNJ), and Colgate-Palmolive (CL) appear in my head. Think about what the failure statements for these companies might look like. What, is Coca-Cola going to suffer under the blow of falling demand for its syrup concentrate? Are the Johnson & Johnson product recalls going to get so out of hand that the millions and millions in baby lotion profits (which is only a sliver of the company) get wiped out? Is the price of oil going to fall off a cliff in such a way or is Exxon Mobil going to be overtaken by some alternative energy that it leads the company to ruin? I'm not saying any of this is impossible-but investing involves predicting the likelihood of future events, and I want to put myself in a position of creating "failure statements" that seem highly unlikely to happen.
I want my investments to consist of failure statements that sound like this. "Colgate Palmolive's record of paying out more and more profits to investors since 1964 will come to an end because people will stop buying Irish Spring soap, Softsoap, Colgate toothbrushes and toothpaste, Speed Stick deodorant, and Palmolive dish soap." Or something like this: "Procter & Gamble (PG) will stop its continuous payout of dividends that dates back to 1896 because people will stop buying Head and Shoulders shampoo, Herbal Essences, Iams pet food, Downy, Pepto-Bismal, Febreze, Duracell batteries, Pampers, and Tide."
That's a large part of why I find dividend growth investing in companies that have storied records of dividend growth to be so appealing- the "failure statements" tend to encompass highly unlikely events. What's the kind of stuff that has rankled us lately? The declining dividend growth rates of companies like Johnson & Johnson and Procter & Gamble. So the firms are granting shareholders a 7% dividend increase instead of a 10% increase. Think about that. We're not worried that these storied firms might go bankrupt, but rather, we're worried that the troubled economic environment is such that we might only get dividend raises at double the rate of inflation instead of triple!
And it's not like we just own one dividend growth stock (with a long record of raising dividends) in our portfolios, either. If you own twenty of these stocks in your portfolio, think about what your comprehensive portfolio "failure statement" might be. Pepsi (PEP) would end its record of increasing dividends since 1973 because the sales of Pepsi, Quaker Oats, and Frito-Lay fell off a cliff. Also, Kimberly Clark (KMB) must end its dividend streak dating back to the same year because people stopped buying Kleenex and Huggies. Also McDonalds (MCD) will have to ends its dividend growth streak dating back to 1977 because people are going to stop buying chicken McNuggets and Big Macs. And those three companies are only 15% of the portfolio-the other 85% is stuffed with companies that share these same historically strong records.
I know that focusing on what needs to go right with our investments is generally the central conversation topic, but as Berkshire Hathaway (BRK.B) Vice Chairman Charlie Munger once remarked, we should spend a fair amount of time trying to avoid "going back to 'Go' on the monopoly board." Sure, there's no guarantee that Johnson & Johnson won't release a defective product tomorrow that harms thousands, triggering billions and billions of dollars in liability that reduce the company to a shell of its former self. But we have to make decisions based on the information that we do have. And I gravitate towards the implicit information that long-term dividend growth companies provide-not only have they managed to survive throughout the rapid technology changes of the 20th century, but they have managed to grow profits in such a predictable way that they can elect to ship off large amounts of cash to shareholders every year in a growing fashion. If I own twenty different companies that have paid out rising dividends for thirty or more years, then I can go to sleep at peace with the way that I am choosing to fail.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
