Dividend Growth Investing: Misguided And Doing It All Wrong

by: David Crosetti


Even with all of the articles that have been written about Dividend Growth Investing, there seems to be no shortage of criticism concerning the strategy. What seems to be the thrust of the criticism is that the Dividend Growth Investing strategy centers on the notions that "it doesn't work," or "it's the wrong approach," or "there's not sufficient diversification."

In a recent article by Larry Swedroe, titled: "Misguided Interest In Dividend Paying Stocks" (here) the author says

Over the last few years we've seen a dramatic increase in interest in dividend paying stocks. The heightened interest has been fueled by both the media hype and the current regime of interest rates that are well below historical averages. The low yields available on safe bonds led even many once conservative investors to shift their allocations from safe bonds to dividend paying stocks. This is especially true for those who take an income, or cash flow, approach to investing - as opposed to a total return approach, which I believe is the right approach.

In yet another article on the subject of the problem with Dividend Growth Investing, Nelson Smith submits an article titled: "Are Dividend Investors Doing It All Wrong?" (here) Smith has this to say about DGI:

If you look at most dividend growth investor portfolios, you'll see a concentration of certain names. McDonald's is a favorite holding, so are Wal-Mart, (NYSE:WMT) Coca-Cola, (NYSE:KO) Procter & Gamble, (NYSE:PG) Johnson & Johnson, (NYSE:JNJ) Pepsico, (NYSE:PEP) Exxon Mobil, (NYSE:XOM) Target, (NYSE:TGT) and perhaps IBM (NYSE:IBM) or Conoco Phillips (NYSE:COP). I've missed a few, but you get the picture.

Where Is The Disconnect?

There have been a number of books written about DGI. If an investor really wants to understand the DGI strategy, perhaps it might be beneficial to read some of these great books on the subject.

I recently came across a blog site where the author, Dividend Pig, provided a list of 10 of his favorite books on the subject of dividend investing. Here is a link to that blog page: here.

Now, there is no shortage of Seeking Alpha authors and readers who practice DGI as a primary strategy. However, a number of those folks who call themselves DGI have nuances on their own approach to DGI.

I believe that this is where many of the misconceptions about DGI seem to come from. Someone might post a comment and that comment is often taken as a bona fide "fact" about DGI. Like I said, there are nuances to each individual investor and because of that, there seems to be a tendency for critics to paint all DG investors with the same broad brush.

Unfortunately or perhaps fortunately, there is no broad brush to DGI. In my own practice of the strategy, many of the things that I do might not appeal to every DG practitioner.

For example, I make it a practice to rebalance my portfolio on a regular basis. Some DG practitioners might say, "Dave, you're selling your winners." But, unlike many DG investors, I am inclined to take profits when a particular holding has had a major run in price and has become overweight in my portfolio.

I used to have a minimum yield threshold of 3% as a current yield point and I would not purchase any company that had a lower initial yield point. Since I now take more of a value approach, I look for companies that are trading at a discount to what I believe their intrinsic worth is. That means I might very well purchase a company with a dividend yield of less that 3% because it represents a potential capital gain situation while I go about collecting the dividends. At some point, I might sell the position or I might decide to keep it and add more money to that position.

In the case of a purchase made last year with Safeway (NYSE:SWY) we decided that when the company gave us a 93% price appreciation that the company had reached an overvalued point and we sold our holding.

In other words, there is no gospel of DGI and every proponent of the strategy will put his or her own metrics into the way that he or she approaches their own portfolio management.

Popular Criticisms of DGI:

1. There are many critics who feel that DG investors do not consider total return, which he some would consider to be the "right approach."

Is there really a "right approach" to investing in the stock market? If that were the case, then wouldn't there only be one investment strategy to choose from? I mean, if there is only one right approach, then it would seem to me that every other approach would have to be "wrong."

There are some people who profess to be DGI's who say that they don't really spend a lot of time looking at total return, because their primary goal is an increasing income stream. That is, growth of their dividends relative to a year-over-year event.

Now I know that some DG investors hold until something happens to the fundamental business model of a stock in their portfolio. I know that others do as I do, that is trim. Some have a rule to sell a position in a company that does not raise the dividend annually, reduces the dividend or suspends the dividend.

2. Some critics of DGI think that those who practice the strategy might be better served in taking a value approach to investments.

I would agree and as a DG investor, that is exactly what I do. I look for companies that are priced at a value to intrinsic worth and buy them. In the case of many of the dividend stalwarts like KO, KMB, CL, JNJ, PG etc. I don't find a lot of value at current price levels. As a result, I am holding those positions in my portfolio and rebalancing to capture gains.

I think that purchasing any stock at any price might not be a wise idea. When a DGI says something like "I'm waiting for a pull-back from current price levels to make a purchase of XYZ" are they not making a valuation decision?

3. Many of these DG investors own the same stocks. Companies like KO, WMT, PG, TGT, XOM, MCD, COP, and PEP to name a few.

I think that one of the reasons that many DGI's own "the same" companies is because many of these companies represent quality. I don't look at it as "group think" but instead as a number of people discovering the same thing about the same companies.

In a DG world that often means a history of increasing dividends annually for a long period of time, it means increasing revenue and earnings, and it means leadership in their category.

Again, I would not argue that every stock represents a valued purchase decision at every point in time. But over the long haul, these dividend stalwarts have performed well for those who own them.

4. DG investors miss out when they "ignore entire sectors such as REITs financials, industrials, and technology."

There is quite a diversified universe of DG stocks, MLPs, and REITs for you to chose from. David Fish has a wonderful list of Dividend Champions, Challengers and Contenders. Here is a link to the dividend list here.

When you look at the list of stocks in this list, you will see that there are 105 Dividend Champions (25-plus years of increasing dividends annually). There are 211 Dividend Contenders (10-plus years of increasing dividends annually). There are 155 Dividend Challengers (5-plus years of increasing dividends annually).

That's a universe of 471 companies that run the gamut from Aerospace and Defense companies to Waste Management companies. Something for all tastes and all preferences. There are financials, industrials and technology companies in these lists as well.

I know that I look forward to the monthly update for the CCC stocks that David Fish provides and I am always amazed at the diversity of companies that make up these lists.

5. DGI's invest in companies that "sell stuff" to consumers.

Yes, we do. Companies that make up the bulk of the CCC lists sell stuff to consumers. That "stuff" takes the form of not only "goods" but also "services." I think it's pretty much a given that when you buy stock in a company, it's going to be a company that sells something to someone.

What You Should Know:

Some DGIs invest in companies that are not part of the CCC lists of dividend payers. Kind of shocking, but many DGI investors look at opportunities where they present themselves. I know that I do. Some of those opportunities are in stocks that might pay a dividend and sometimes they might be in stocks that do not pay a dividend.

Again, I think that in the universe of DG's there is no "one size fits all" even though many of us agree on some basic fundamentals of investing.

For me, again, having a value bent, I will buy companies that may not currently be on the CCC lists. Recent purchases that I've mentioned in my latest articles include, Caterpillar (NYSE:CAT), Deere (NYSE:DE), Holly Frontier (NYSE:HFC), Questcor Pharmaceuticals (QCOR), Qualcomm (NASDAQ:QCOM), Capital One Financial (NYSE:COF), Oracle (NYSE:ORCL), Schlumberger (NYSE:SLB), Joy Global (NYSE:JOY), F5 Networks (NASDAQ:FFIV), and Cognizant Technology (NASDAQ:CTSH) to name a few recent purchases.

Some Final Thoughts:

I am not exactly sure where this notion of "everyone has to invest like me" comes from. I know that more and more each day, it seems that someone wants to tell me that what I'm doing is wrong, ill-advised, or plain silly.

But, every one of us is different. We have all had experiences that shape our investment strategies and those are usually based on some track record of success.

We tend to stick with the things that are working for us and hopefully avoiding hanging onto strategies that have not. To decide that we do not like a particular investment strategy and choose not to practice it does not make us any more or less "right" about our strategy than someone else's strategy.

Knowing what your goals are creating a plan to execute against those goals, sticking to what is working and changing what is not seems to me to be the best criteria for success.

So if you are a DG investor, good for you. If you are a growth investor, good for you. If you are a combination of both or some completely different method, good for you.

Just remember that my money is my money. How I choose to invest it is my decision - not yours or anyone else's. Neither is how you choose to invest any of my concern.

Disclosure: I am long CAT, COF, CTSH, DE, FFIV, HFC, JOY, ORCL, QCOM, QCOR, PG, KO, JNJ, WMT, KMB, CL. 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.