Some Tips on a Dividend Growth Strategy

I have been getting several e-mails of late asking for more details on my dividend growth strategy for stock selection. While I am always happy to respond, I thought I could share a few things with you here.

I recently read a great article from Forbes that is an interview with Cohen & Steers Dividend Value Fund portfolio manager, Richard Helm. It was a very well laid out interview and contained some key points that outline my strategy explicitly. (It’s always reassuring to know that there is a professional money manager who thinks like you do).

Dividend Growth is Key

As I have recently noted in my previous articles on buying dividend growth stocks, the rate at which the dividend grows is as important, if not more important, than the current dividend yield. This is because we are focused on growing our income stream from these stocks to provide an ever-increasing stream of income as we work toward (early) retirement!

Here is Helm’s position on this subject:

Helm has an unusual approach to ferreting out dividend stocks because his primary focus is on finding companies that will more than just maintain their dividends. Helm wants dividend growers and he is willing to take a chance on companies with low current yields, as he expects earnings growth to drive payout growth.

Dividend Growth Versus Share Buybacks

I have written previously about why I don’t like share buybacks and prefer to see dividend growth instead, an issue that Helm tackles in this article as well. While share buybacks can increase overall shareholder yield if executed correctly, Helm echoes my sentiment that buybacks are more lucrative to company management than shareholders.

…When you think of how management can allocate cash flow, which is the lifeblood of any business, they can purchase another company, or invest in a new venture, or buy back debt, or buy back shares, or raise the dividend. Of those options, the one that tells us that management has the most confidence in their existing business, is raising the dividend.

A merger or acquisition doesn’t always yield the synergies that management thinks it will. As for buying back shares, most buybacks are never fully executed, and studies show companies issue more shares than they buy back. They issue them through management stock options.

The Dividend Payout Ratio

Another part of the dividend growth stock picking strategy is to find companies with a dividend payout ratio that is relatively low. This makes intuitive sense, because the company needs to retain profit to drive growth and earnings, which it can then use to increase the dividend rate.

Helm had the following to say regarding payout ratios:

[…] the reason is that there is room to bring those up. Look at the big telecom names. They have big payout ratios. So their ability to raise their dividends is hampered. They are generally less attractive to us.

Focus on the CFO

A focus on great management and changes in management are key when selecting stocks. I tend not to focus on changes in management as much as the history of the company management as a whole. However, Helm brings up a great point about keeping focus on the CFO instead of the CEO with regard to management change.

Why the CFO?

The CEO says where he wants to go; the CFO tells him how to get there. [In] most cases, he is the next in line for the throne. For him to leave, it tells you something. Now, maybe they got the CEO position someplace else. But, a lot of times, there is an issue. We want to know what it is.

Helm goes on to mention a few stock picks and also has some interesting things to say about his outlook on financial stocks. He does mention taking a look at the strength of the brand when evaluating financial stocks, and indicates the strong brands, such as Citigroup. Some of these strong brands have been discounted immensely for exposure to sub-prime credit, but still offer excellent franchises in retail banking as well as brokerage firms. Is there more value there?