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Proponents of dividend growth investing (or DGI for short) claim that by selecting stocks with a solid track record of annual dividend increases and re-investing the proceeds they are compounding the income stream for a retirement where the capital does not need to be touched. Those who disagree with the dividend growth strategy claim that you can achieve the same effect with non-dividend stocks where you focus on building your capital gains and draw from the principal at retirement.

Dividend growth investors have back-tested the strategy using a compiled list made available by Seeking Alpha author, David Fish, while others argue that this list suffers from survivorship bias. Put another way, the current list does not show companies that cut their dividends or went bankrupt, even in 2008/2009?

This article will shed a little more light on the historical track record of dividend growth investing while still leaving the door open for debate and further research.

Back-Testing Dividend Growth Stocks

The back-testing platforms I typically use either have a limited time frame to test dividend growth strategies in (roughly 10 years) or lack the capabilities to test is free of survivorship bias. Since I am a beta tester of a back-testing platform called Quant Advisor, I politely asked (begged is more like it) the CEO and Co-Founder to include the ability to back-test dividend growth stocks. As this platform grows I will be able to test dividend growth investing more rigorously in conjunction with numerous strategies, but for now it should offer some decent bias-free preliminary results.

Please note that the results outline capital growth only and do not include dividends or re-investment of dividends. At this point we are comparing share price only and dividends need to be extrapolated.

10 Years of Increasing Dividend Growth

The test is run from the beginning of 1994 to the beginning of 2012. All stocks with at least 100 million market cap and 10 years of increasing dividends are included with annual rebalancing.

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This works out to a compound annual growth rate of 7% before taking into consideration any dividends. The most recent list of stocks gives an average yield of 3% while the average would be slightly higher. This would mean an average annual return of 10% - 11%. A total of 797 companies were tracked during this 18 year period.

Compare this to the S&P 500 with a total return CAGR of 7.71%.

Dividend Growth War Wages On

This raises many more questions... what about deep value dividend growth stocks as opposed to high-growth dividend stocks? What role does yield play? What is the difference between stocks with long track records such as those in the Dogs of the Dividend Aristocrat Portfolio which includes Johnson & Johnson (JNJ) and Procter & Gamble (PG) vs. those with shorter track records such as Imperial Oil (IMO) and Nike (NKE)? Can we get more specific with the breakdown between income, capital gains, and income growth? What further strategies can be built around this universe to capitalize on the lower drawdown and higher average returns?

Sometimes when you attempt to answer one question you raise 10 more.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.