Originally published on Sep. 29, 2014
Mindset is a simple idea discovered by world-renowned Stanford University psychologist Carol Dweck in decades of research on achievement and success... a simple idea that makes all the difference.
In a fixed mindset, people believe their basic qualities, like their intelligence or talent, are simply fixed traits. They spend their time documenting their intelligence or talent instead of developing them. They also believe that talent alone creates success... without effort. They're wrong.
In a growth mindset, people believe that their most basic abilities can be developed through dedication and hard work ... brains and talent are just the starting point. This view creates a love for learning and a resilience that is essential for great accomplishment.
When it comes to mindset, I'm reminded of my basic training in the Marine Corps decades ago.
Where the Marines are different from the other branches of the military is that they are not trained to fight a war or their role in it during their boot camp training.
Marine Corps boot camp is spent on how to teach you to think like a Marine. You don't get the right to learn how to fight in a war, or learn your role in it, until you know how think and act like a Marine. Those who earn the right move on to Infantry Training in Camp LeJuene, NC.
While visiting my Navy son and friends on a military base, they were laughing and doing high fives because they were off duty and celebrating over quite a few adult beverages, while the off-duty Marines were involved in a pushup contest.
I told my son, that's what Marines do. That is what is expected of them. That is their mindset.
Dividend growth investing takes a certain mindset too, if one wants to succeed at it. Dividend growth investing is different from most styles of investing because the application of the strategy is different from what most people are used to, or have experienced in the past.
This article is going to attempt to explain the dividend growth investing strategy as I understand it to be applied, and it is certainly the mindset that I have and apply.
There should be some way to have a simple investment program that makes sense, is easy to implement, and has a high chance of succeeding in meeting a set of long-term goals.
Dividend growth investing is a plan for builders and savers who understand, or want to understand, that the forces of time, modest and reliable growth, and compounding are on their side.
Investing is the methodical accumulation of capital through a disciplined and sensible plan that recognizes that shares are not little numbers that jump around in the paper every day. They represent a partnership interest in a real and ongoing business, a business that earns a decent profit, shares that profit with you, and grows the amount of profit shared on an annual basis.
A dividend growth investor knows that their portfolio value will go up and down, as this can never be avoided if you are to have reasonably good long-term gains. However, a dividend growth investor won't be bothered by the downs, because they understand why the price is down, and they know that prices will rise over the long run. Their confidence level is high because the strategy is based on common sense.
Common sense dictates that the only hope for long-term success is having the ability to stick with the plan.
Common sense in investing means employing a strategy that is actually linked to the companies in which you've invested. Investing is about being a partial owner of a real business.
Common sense means spreading out your risks, but not so much that you lose control over your portfolio.
Commonsense investing is about establishing a comfort level that allows you to stay calm while others around you are in the state of panic or deep concern.
When you lose your comfort level, you become fearful, greedy, superstitious, intuitive, prayerful and victimized. You enter into an emotional state that ultimately provokes investing mistakes.
Dividend growth investors manage equity portfolios for dividend growth because we happen to believe it is the best strategy for making money in the current economic and financial environment.
I believe that a portfolio that provides a steady and growing stream of dividend income is the best way to finance a secure retirement without having to worry about the fluctuation of stock prices.
Most investors ask, "What's my account's current value?" A dividend growth investor asks, "How much dividend income did my portfolio generate?"
Most investors ask, "How much was my account up or down this year? A dividend growth investor asks, "How much did my account's income grow this year?"
Most investors ask, "Where is the stock market going this year?" Dividend growth investors don't try to predict short-term swings in the market.
A dividend growth investor doesn't focus on capital appreciation, because we never know when it will show up. A dividend growth investor is more concerned with the safety of the dividend and its potential for growth. A dividend growth investor understands that if a company is solid enough to continue paying and raising the dividend, capital appreciation will follow.
When I look at a Coca-Cola (NYSE:KO), for example, I see where Value Line Survey has it rated 1 for safety and A++ for Financial Strength. There is no higher rating, this is the best of the best. On the other hand, Value Line has KO's Timeliness rating at 5, which is the worst rating possible. What this means is that they don't expect KO to outperform the market over the next 6 to 12 months.
If one is looking for capital appreciation and more momentum interested in their investing, then KO isn't for them at this time. However, as a dividend growth investor who thinks KO will continue to survive and earn a profit, this is an ideal situation for me to build the position. I reinvest all dividends back into KO at these prices, which increases the amount of income I can receive, as opposed to reinvesting into rising prices. It's common sense.
Over the last 5 years, while reinvesting the dividends back into KO, my compounded annual rate of return with regard to the dividend is 11.26%. Now think about that. KO is giving me an 11%-plus cost of living increase every year. Given income growth is the objective of a dividend growth strategy, hence the term dividend growth, KO is an ideal company to own.
I don't wish to sell an asset generating 11% annual returns in income with the safety ratings of KO - I want to own more of it. If I don't wish to sell, why should I care if it outperforms the market or not? KO's underperformance actually provides even more income. The more income KO generates, the more people will want it, and the more people that want it, the more the price will rise higher eventually.
Dividend growth investors understand the power of compounding. The very essence of the dividend growth strategy is to compound your money at an acceptable rate of return for as long as you can. If you're able to do that, you'll end up rich.
Colgate-Palmolive (NYSE:CL) is another company that is a perennial overvalued company that is considered low-to-no growth, yet my 5-year compounded annual growth rate on the reinvested dividends is 13.02%. A dividend growth investor should be rejoicing over those income growth numbers and not worrying themselves over share price.
When you stop and think about it, compounding double-digit growth rates over a 20-, 30- or 40-year time frame is astronomical. Dividend growth investing is about dividend growth, not just buying companies that pay a dividend.
It takes the proper mindset to make the subtle distinctions between high-yield investing and dividend growth investing, and it takes a major mindset conditioning to wean your thoughts away from worrying about shares prices.
Dividend growth investors understand that focusing on capital appreciation is the most difficult way to try and achieve consistently positive returns from investing in stocks, much less consistently high returns.
If investors truly understand the power of compounding, they would have the confidence to stay invested and continue to invest regularly, regardless of how the market is doing.
Dividend growth investors understand the power of regular cash flows for their portfolio. Until those cash flows are being received as income, they are investable monies that can be used to grow your portfolio even more. I liken it to the concept of using other people's money to grow.
How do we generate cash flow to our portfolio? We do it by locking in yields in excess of 50% above the yield provided by the S&P 500. We look for companies that can grow their dividend at a rate above inflation. The combination of dividend yield and dividend growth is a powerful contributor to the compounding equation. A dividend growth investor will then reinvest all of those growing dividends to earn a "double compounding" effect on our money.
During the mid-60s, Warren Buffett said that he figured out that while having cheap stocks was nice, buying companies that could produce positive and growing cash flow that he could allocate to other profitable investment opportunities was a much better way to invest. Buffett said that if he was able to buy a good company with reliable cash flow at a cheap price, all the better, but what he was after was control of a steady and growing cash flow.
It was the cash flow that allowed Buffett to do a number of things, including investing in other promising businesses, or buying the company outright.
It's those monthly cash flows to the portfolio that the successful dividend growth investor focuses on, not capital appreciation.
In summation, the dividend growth strategy is about purchasing a business partnership in an ongoing, high-quality business that shares the profits with you and grows those profits annually. The dividend growth investing mindset is for builders and savers who understand that time in the market will perform better than trying to time the market. The dividend growth investing mindset is about understanding and utilizing the power of compounding and then reinvesting those dividends to get a double compounding effect.
The dividend growth investing mindset is a commonsense approach to investing.
Sources: "The Single Best Investment" by Lowell Miller, "Views On Investing" by Mark Deschaine
Disclosure: The author is long KO, CL. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.