Dividend Growth And Capital Growth Can Co-Exist In The Same Portfolio

by: David Crosetti


As a Dividend Growth investor, I am drawn to stock in companies that pay dividends. I like stock in companies that have a history of increasing those dividends on an annual basis and I especially like those companies that have done so for at least 5 years in a row.

A list of companies that meet these criteria is maintained by David Fish, a frequent Seeking Alpha contributor and author. David breaks these companies down into three categories. They are called Dividend Champions, Contenders, and Challengers.

Now, does the fact that these companies have increased their dividends on an annual basis mean that they are all stocks that you should own? Of course not. Does the fact these companies have increased dividends for a minimum of five years in a row mean that they will continue to raise their dividends for the next five years in a row? Of course not. Have there been companies on this list that have stopped raising their dividends and no longer meet the criteria for inclusion on the lists? Again, yes, there have been companies that have been dropped from the list because they have failed to continue raising their dividends on an annual basis.

What You Need To Know:

In a recent article that I wrote, "Dividends Do Matter, But There Are Two Sides To Every Story," I wrote the following:

The question seems to keep being asked. "Do dividends matter?" That's such a great question! As a DG investor, I would answer in the affirmative. Yes, dividends do matter. As a growth investor, however, I might want to argue that dividends really don't matter. I am interested in capital gains. On the surface, your opinion should be based on your personal investment strategy and goal, but an opinion it is, nevertheless, and it's one that stirs a lot of debate.

Needless to say, the article received a lot of discussion and commentary and there was a good deal of debate.

What I Know:

There seems to be some question concerning Dividend Growth stocks as a practical and viable investing strategy. Often times, the criticism seems to come from a philosophical point of view that does not always take into account the nature of investing. Whether one is a DG investor or a Growth investor, many of the metrics that we use are exactly the same. However, it seems to me that investors in both camps don't seem to realize that and both groups seem very content to paint one another with a very wide brush, indeed.

When I am in the market to purchase stock in a particular company, I have a certain set of steps that I perform. In every case, for me, I begin by running a screen. That screen will be the criteria that I use to take a list of all the stocks in the SP 500 and filter them out so that I arrive at a culled list of potential purchases. My most critical metric is the Price Earnings Ratio. I like to run three PE ratios. First is the PE for the most recent full year; second is for the trailing 12 months; and third is for the full year forward. Doing that eliminates a lot of companies. Why is PE important? For me, it identifies the stock price, relative to earnings. It is an indicator of what I will be paying for every dollar of earnings. So if a stock has a PE of 15 and I chose to buy it, then what I am saying is that I am willing to pay $15 for every $1 of earnings that the company is producing.

I use other metrics as well and any investor who is serious about investing will have his or her own list of metrics. Each one is significant in what it points out about a specific company. There is Debt to Equity; Free Cash Flow; Return on Equity; Price to Earnings Growth and many more criteria that you can filter.

Once I have created a list of likely candidates, the next thing that I do is look at analyst reports on the company. I use the reports provided by Charles Schwab. Those are Ned Davis, Argus Research, Credit Suisse, Reuters, and Standard and Poor's. This second is part of "peeling the onion." It's weeding out the good, the bad, and the ugly, from my list of potential investments

As a final step, I use F.A.S.T. Graphs to give me a visual presentation of each of the remaining stock selections from the perspective of value. Are the finalists value priced from the perspective of the F.A.S.T. Graph model or not? If they are, then the make the final cut and go onto my acquisition list regardless of their dividend paying status. What I have discovered, over time, is that many of my final cut stocks happen to be dividend payers and many of them also happen to be Champions, Contenders and Challengers.

Some Interesting Myths:

To assume that DG investors do not perform due diligence in regard to their stock selection is naive at best. Most DG investors do not put their capital at risk to purchase any old stock at any old price. Instead, successful DG investors take the time to begin with a set criteria, run screens and find likely candidates to add to their portfolios.

It is also naive to assume that DG investors will hold a particular stock forever. Not the case. Most DG investors have very well defined reasoning behind the elimination of a stock from their portfolio. It may be that the company has cut or suspended a dividend increase. It may be that a better place to have their capital invested has been found. It may be that a company has had a new challenge to their business model and is no longer a company that can deliver continued growth.

Many critics argue that DG investors are only looking backward. Past results are no guarantee of future success. That being the case, why would a DG investor take the time to run a screen and do due diligence if the only thing they were relying on was past performance? They wouldn't. But, by the same token, sometimes the past can be an indication of what may happen in the future.

Summary and Conclusion:

There are many Dividend Champions that on the surface would appear to be stocks that the average DG investor might choose to own. Some of my favorites are: Abbott Labs (NYSE:ABT), Altria (NYSE:MO), Aflac (NYSE:AFL), AT&T (NYSE:T), Chevron (NYSE:CVX), Coca-Cola (NYSE:KO), Colgate Palmolive (NYSE:CL), Emerson Electric (NYSE:EMR), ExxonMobil (NYSE:XOM), Illinois Tool Works (NYSE:ITW), Johnson and Johnson (NYSE:JNJ), Kimberly Clark (NYSE:KMB), McDonalds (NYSE:MCD), Procter and Gamble (NYSE:PG), Target (NYSE:TGT), Walmart (NYSE:WMT) and Walgreens (WAG).

These stocks have paid and increased dividends for more than 25 years in a row. Some of them are increasing those dividends at a rate that is greater than inflation. At various times in the past, each of these companies was priced at a relative value to the company's intrinsic value.

There are many companies that are on the Dividend Challenger list. These are companies that have increased dividends annually for at least 5 years. Some that I currently hold are: Intel (NASDAQ:INTC), Hasbro (NASDAQ:HAS), Microsoft (NASDAQ:MSFT), Reynolds American (NYSE:RAI), Verizon (NYSE:VZ), and Waste Management (NYSE:WM).

These stocks have been purchased at various points in time and have been bought with value pricing relative again, to intrinsic value. Some of these may very well progress to Dividend Contenders and perhaps to Dividend Champions at some point in the future. But, by the same token, they might fall off the list altogether.

Here are some stocks that I own that are not CCC stocks. General Electric (NYSE:GE), DuPont (NYSE:DD), Kraft Foods (KFT), Merck (NYSE:MRK), Pfizer (NYSE:PFE), Phillips 66 (NYSE:PSX), Bristol Meyers (NYSE:BMY), Cisco (NASDAQ:CSCO), Annaly Capital (NYSE:NLY) and Exelon (NYSE:EXC). These companies were purchased at different times and again, with value pricing in mind. EXC is the most recent addition to the holdings.

Finally, there are a number of stocks that I am still researching and making my mind up about purchasing them or passing. Some of these happen to be dividend paying stocks. I am looking at Cliffs Natural Resources (NYSE:CLF), Staples (NASDAQ:SPLS), Corning (NYSE:GLW), Cummins (NYSE:CMI) and Safeway (NYSE:SWY) to name a few.

Every investor manages his or her own portfolio their own way. To suggest that one particular investment strategy is superior to another is foolish, at best, but to completely discount a particular investment strategy because you don't currently use it is even more foolish.

Disclosure: I am long ABT, DD, GE, MCD, NLY, RAI, VZ, XOM, AFL, EMR, HAS, KFT, MO, PFE, WAG, BMY, CSCO, EXC, INTC, KMB, MRK, PG, WM, CL, CVX, GE, ITW, KO, MSFT, PSX, T, WMT. 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.