Dividend Growth Investors Are Fine On Their Own

Includes: BDX, KO, LMT, WTR, XOM
by: The Conservative Income Investor

I was recently reading Michael Pollock's article on dividend growth investing in the Wall Street Journal, and he spent most of the time talking about various funds and money managers that come close to approximating the dividend growth experience in fund or ETF form. This is a particular subject of interest to me because it seems that out of all the types of investors out there, the dividend growth investor seems particularly likely to prefer buying individual stocks that he is familiar with as opposed to handing the funds over to a money manager or a mutual fund. This is a fascinating topic to me because you would think that with all of the funds out there, it ought to be possible to come up with some type of index or fund that can come close to replicating a recognizable form of dividend growth investing. But as I started reading the article, I quickly realized that there might be a sharp dissonance between what dividend growth investors want and what the financial services industry thinks that dividend growth investors need.

One thing Pollock says is this: "For many investors, mutual funds are the most practical way to get exposure to stocks that pay dividends. Unless you have several hundred thousand dollars to invest, you probably can't buy enough individual stocks to get reasonable diversification in your portfolio." Out of all the various strategies out there (except for perhaps indexing), dividend growth investing seems to be very easy to implement without needing large sums of money.

I think it's wrong to suggest that an investor needs hundreds of thousands of dollars to get reasonable diversification from dividend growth companies. I just went to computershare.com to see what kind of investment portfolio an investor could put together from this site while aiming to: (1) buy dividend growth stocks, (2) keep costs low, and (3) achieve a semblance of diversification.

Let's see - you can invest $100 per month into Exxon Mobil (NYSE:XOM) for $0 per month, you can invest $100 into Aqua America (NYSE:WTR) for $0 per month, you can invest $100 into Coca-Cola (NYSE:KO) for $1.00 per month, you can invest $100 into Wal-Mart for about $1.10 each month (I say about because the company charges $0.05 per share in processing fees), you could invest $100 into Beckton Dickinson (NYSE:BDX) for $0 per month, and you can invest $100 into Lockheed Martin (NYSE:LMT) for $0 per month. Adding it all up, you can buy shares of an oil company, a water company, a beverage conglomerate, a retail giant, a medical device cash cow, and a defense firm all at the same website for just $2.10 per month, giving you a transactional cost of 0.35% of total investment. These numbers are for an investor who is looking to autopilot about $7,000 worth of investments per year, which is a far cry from the "several hundred thousand dollars" that the author claims is necessary to achieve diversification.

One thing that I take exception to is the notion that investors ought to reach a particular portfolio allocation overnight. Let's say that you're just starting out and are planning to invest $4,000 per year for the next ten years, and mentally, you don't want a holding to take up more than 10% of your portfolio. From a cost perspective, it would most likely be foolish to establish 10 stock positions of $400 each. There's nothing wrong with an investor buying $4,000 worth of Coke in 2012, $4,000 worth of Wal-Mart in 2013, $4,000 worth of Beckton Dickinson in 2014, $4,000 worth of Exxon-Mobil in 2015, and so on. Diversification takes on greater importance as you reach sums of money that are increasingly difficult to regenerate (having 100% of your portfolio in Coke is a different story when you're talking about a $4,000 investment than when you're talking about a $400,000 investment), and most of these financial articles act as if diversification is something that is supposed to happen all at once, as opposed to something that can happen over several years to even decades.

But my greatest concern with Pollock's article came when he turned to Morningstar analyst Christopher Davis to justify the 1-2% expense fees that can nullify a large percentage of the dividend income. Davis opines that "the biggest advantage of actively managed funds is the expertise behind them: A professional manager can judge when a company is financially solid enough to maintain, or even raise, its current dividend, and it might be tough for casual investors to make that call." This requires the reader to take a leap of faith that I'm not willing to make. If you look at the dividend articles on Seeking Alpha, you can tell that a disproportionate few get most of the attention-there's almost always a focus on companies like Coke, Pepsi (NYSE:PEP), Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ), and Colgate-Palmolive (NYSE:CL). These are companies that it does not take an expert money manager to gauge the safety of, and it seems within the realm of the so-called casual investors to make the call.

Granted, the audience at the Wall Street Journal is not the same as that of Seeking Alpha. Unfortunately, I would wager that far too few of the WSJ readers are familiar with David Fish's CCC Lists. But still, there seems to be a bit of a paradox at play here. In order for an investor to desire putting his money into dividend growth funds, he has to be familiar enough with dividend stocks to know that he wants them to be a part of his portfolio. And if you're at that stage of knowledge, you can probably figure out that Coke, Pepsi, Johnson & Johnson, and Procter & Gamble are some of the bluebloods that could find a place in almost any dividend growth investor's portfolio. This isn't so for other investing niches-if you want to invest in China, it's not readily apparent who the "kings" of the Chinese stocks are. Likewise, if you want small-caps in your portfolio, you might not be able to tell which $300 million company will be here today and gone tomorrow, so it might make sense to enlist the help of some expert managers. But when it comes to dividend growth investing with large-caps, you can look at payout ratios, dividend growth history, brand names, and the strength of global brands to reach conclusions without the aid of expertise.

A common trait among many dividend growth investors is a desire to generate enough income to either meet expenses or pay a large chunk of expenses during working years (to enhance a lifestyle) or during retirement. If you're planning on living off of that 3-4% annual income generated by dividend stocks, it seems very foolish to agree to pay 1-2% in management fees and send a third to half of your dividends out the door to investment managers. With DRIP plans available that charge from $0-$2 per month, and the ability to identify the dividend champions with the strongest brands and track records, it seems foolish to agree with the expectations of fund managers that investors need mutual funds when they have limited funds or should be willing to shell out tens of thousands of dollars in fees if they have a high six-digit portfolio.

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