'Dividend Growth Investing' Without The Dividend Growth

Includes: DIS, GE, IBM, JNJ, PG
by: Steven Bavaria

My goal as a long-term investor is to constantly grow the income flow from my portfolio. There is more than one way to do that.

You can invest in assets that individually grow their own dividend year after year ("organic" year-over-year growth) and hope the market notices and moves the market price up accordingly.

Or you can invest in higher yielding assets that may never grow their own individual dividend, and create your own portfolio income growth through reinvestment and compounding.

The first is called "Dividend Growth Investing" and is what most professional investment managers and writers have been recommending for generations.

The second I call "Income Factory" investing. It lets me sleep better at night and actually view downturns as opportunities for accelerating income growth.

When I first wrote an article (Confessions of a "Lapsed" DGI Investor)suggesting we could achieve the same long-term income growth results as traditional "dividend growth investing" (DGI) by re-investing and compounding higher yielding asset classes that anticipate no growth whatsoever in the dividends or market values of the individual instruments, the response from some readers was - let us say - skeptical, to say the least.

Undaunted, I followed up with additional articles ("the rematch" and others), and more importantly, continued to put my ideas to work with very satisfying results. (See below for 25-year results, with an average annual return of 11.2%.)

This strategy, which I originally called "income growth" but now tend to refer to as the "Income Factory," aims to achieve a long-term "equity return" of about 10%. That will double your investment every seven years, which means $10,000 will grow to over $600,000 in about 40 years, a growth rate that should satisfy anyone with a long-term investing outlook, whether 25 years old or 60 years old.

I caution my regular readers that this will repeat a lot of familiar themes already covered in many of my regular quarterly reports and other articles. But since my Income Factory strategy has been gaining more traction and support from a subset of SA readers and followers, I thought a theoretical overview might be useful for newer readers who may be open to an "outside the box" alternative.

What distinguishes my strategy are several key features:

  • I try to achieve virtually all of the 10% or so of "equity return" in the form of cash dividends or distributions, not from a conventional "dividend growth income (DGI)" strategy.
  • DGI investors would look to achieve a similar total return goal via perhaps 2 to 4% cash dividends and the remaining 6 to 8% in annual dividend growth; the assumption being that the dividend growth would translate into market price appreciation, which indeed it will if a rational market adjusts prices upward as the dividends increase so as to keep the current yield the same; i.e. if a stock yields 5% and increases its dividend 10%, the stock price should rise to a level where the new higher dividend represents 5% of the new higher market price.
  • Unlike DGI investors, I will be happy if my investments never increase their dividends or their market prices.
  • I create my own portfolio income growth through re-investment and compounding. If I'm collecting 10% or close to it in cash, then I can re-invest and compound that income and achieve the exact same growth as another investor who only collects 2 or 3% in cash and relies on dividend increases of 6 or 7% a year to make up the difference.
  • This is illustrated in detail in the spreadsheets below.
  • The "machines" (i.e. individual investments) in my Income Factory are not expected to increase their individual income stream, but by using the factory income to constantly buy new machines, I am increasing the factory's total output. If the factory itself (i.e. my investment portfolio) were viewed as a stock, it would clearly be a growth stock.
  • In this way, I have more control over my own investing destiny, so to speak, since I am not depending on the companies or funds I invest in to continue to increase their dividends into the future.
  • Nor am I depending on "the market" to recognize the increasing dividends in the stocks' market prices; thus removing the "wishing, hoping and waiting" element of the DGI strategy. Since my portfolio will grow as long as the assets I own continue to generate their current level of cash flow, no growth is required, either in dividend level or in market price.
  • This effectively removes much of the angst associated with waiting for and/or worrying about market downturns, since drops in market price actually allow me to accelerate my portfolio income growth by providing reinvestment and compounding opportunities at bargain prices and higher yields. (If sleeping well through troubling market periods is important to you, than this is a key feature. Check out the "It Don't Worry Me" article for more details on this.)
  • Finally, another key difference is that I do not believe you need to actually hold equity (i.e. stocks) in order to earn "equity returns." This opens up many additional asset classes for consideration besides traditional corporate equity. If you think a bit outside the box, there are ways to achieve an equity return that actually involve taking other kinds of risks (i.e. making different kinds of investment "bets"), many of which have more attractive risk/reward characteristics than typical corporate equities. I especially like credit market assets of various types and have written extensively about these (See "Will the Horse Finish the Race?") Remember that every time you buy stock in a company you are taking its credit risk as well as its equity risk, since stockholders get nothing if a company doesn't pay its debts. So buying a firm's stock instead of its debt is a bad deal unless you are certain you will make more on the stock than you would just holding its debt.
  • This article is essentially about the theory behind the Income Factory approach. Readers looking for specific investment ideas or candidates will find lots of ideas and a complete list of my latest portfolio holdings in my quarterly reviews. The list of asset classes that are candidates for an Income Factory includes closed end funds of various types, business development corporations ("BDCs"), REITs, utilities and infrastructure (including MLPs), senior secured corporate loan funds, high yield bonds, collateralized loan obligations ("CLOs"), etc. Check out last month's quarterly review of the "Savvy Senior" portfolio for the most recent portfolio list. (This is not a paid service, nor is this a "bait and switch article" to sell you on a subscription service of some sort. So indulge, and let me know what you think.)
  • One other note: This strategy is most appropriate for a tax-deferred account, like an IRA, where you don't have to worry about taxes on the reinvested dividends, which detract from the compounding and reinvestment impact. A DGI approach, where more of your total return is in long-term capital gains that may be taxed later and at lower rates, makes more sense in a taxable account.

Questions And Concerns (Hint: The Math Works!)

I know from past experience that there will be some who have been trained or even indoctrinated in the belief that unless you buy individual stocks that are long-term growth prospects (e.g. "dividend champions" and the like), you cannot create a truly growth-oriented investment strategy. I am not suggesting that successfully picking the Disney (NYSE:DIS), General Electric (NYSE:GE), Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ) or IBM (NYSE:IBM) of the future will not be a satisfying long-term strategy, just as it was in the past. But it is not the only way to achieve long-term steady growth.

The following spreadsheets clearly demonstrate that an Income Factory (i.e. all cash yield) approach provides exactly as much total return as a DGI approach where the sum of the DGI yield-plus-dividend growth equals the dividend-alone of the Income factory. Three cases are shown:

  • The first is a typical DGI Low Dividend, High Growth case with a dividend yield of 2% and annual dividend growth of 8%.
  • The second is a DGI Higher Dividend, Modest Growth case with dividend yield and annual growth of 5% each.
  • The third is an Income Factory case with a 10% yield and no annual dividend growth.
  • In every case, the total return each year and cumulatively over ten years is the same for each portfolio. The only difference is where the income comes from: i.e. the DGI Low Dividend/High Growth model gets 20% of its total return from cash income and 80% from capital appreciation, over a ten-year period. The DGI 5% Dividend/5% Growth model, as you would expect, gets 50% of its total return from cash dividends and 50% from growth. The Income Factory model gets 100% of its total return from cash.
  • In the "real world," the market does strange things, so both the DGI and the Income Factory portfolios will experience market movements up and down ("paper profits and losses"). The point of the Income Factory approach is that while those movements up and down will affect the market value of the factory producing the cash flow, they have minimal impact on the cash flow itself and on my ability to compound and grow that cash flow over time.
  • Caveat: This approach is for people focused on growing the cash flow (income) from their investments, NOT focused so much on how much the market values the portfolio that is the source of that income. If you are saving and investing for retirement, this is a great approach. if you are saving and investing shorter term, where you plan to sell your portfolio in the relatively near future to buy a house or a boat or a car or send your kids to college - i.e. where the ability to sell all or most of it for cash at some specific time is critical - then you do have to worry more about the market value of your factory and not just the cash output, and a more traditional "total return" strategy may be appropriate.
Dividend Growth (Low Div - High Growth # Shares at Start of Period Beginning Share Price Dividend Rate (Yield) Div Growth Rate Div Rate ($$) Per Share Next Year's Div Rate New Mkt Value in Anticipation of New Div Rate This Year's Div income This Year's Cap Apprec. Anticipating Div Increase Total Return Total Return % New Shares Bought w/Reinvested Dividend
1st Yr 1 100 2% 8% 2 2.16 108 2 8 10 10.0% 0.019
2nd 1.02 108 2% 8% 2.16 2.3328 116.64 2.20 8.80 11 10.00% 0.019
3rd 1.04 116.64 2% 8% 2.33 2.52 125.97 2.42 9.68 12.10 10.0% 0.019
4th 1.06 125.97 2% 8% 2.52 2.72 136.05 2.66 10.65 13.31 10.0% 0.020
5th 1.08 136.05 2% 8% 2.72 2.94 146.93 2.93 11.71 14.64 10.0% 0.020
6th 1.10 146.93 2% 8% 2.94 3.17 158.69 3.22 12.88 16.11 10.0% 0.020
7th 1.12 158.69 2% 8% 3.17 3.43 171.38 3.54 14.17 17.72 10.0% 0.021
8th 1.14 171.38 2% 8% 3.43 3.70 185.09 3.90 15.59 19.49 10.0% 0.021
9th 1.16 185.09 2% 8% 3.70 4.00 199.90 4.29 17.15 21.44 10.0% 0.021
10th 1.18 199.90 2% 8% 4.00 4.32 215.89 4.72 18.86 23.58 10.0% 0.022
31.87 127.50 159.37
Dividend Growth (High Div - Low Growth # Shares at Start of Period Beginning Share Price Dividend Rate (Yield) Div Growth Rate Div Rate ($$) Per Share Next Year's Div Rate New Mkt Value in Anticipation of New Div Rate This Year's Div Income This Year's Cap Apprec. Anticipating Div Increase Total Return Total Return % New Shares Bought w/Reinvested Dividend
1st Yr 1.000 100 5% 5% 5 5.25 105 5 5 10 10.0% 0.048
2nd 1.048 105 5% 5% 5.25 5.5125 110.25 5.50 5.50 11 10.00% 0.050
3rd 1.098 110.25 5% 5% 5.51 5.79 115.76 6.05 6.05 12.10 10.0% 0.052
4th 1.150 115.76 5% 5% 5.79 6.08 121.55 6.66 6.66 13.31 10.0% 0.055
5th 1.205 121.55 5% 5% 6.08 6.38 127.63 7.32 7.32 14.64 10.0% 0.057
6th 1.262 127.63 5% 5% 6.38 6.70 134.01 8.05 8.05 16.11 10.0% 0.060
7th 1.322 134.01 5% 5% 6.70 7.04 140.71 8.86 8.86 17.72 10.0% 0.063
8th 1.385 140.71 5% 5% 7.04 7.39 147.75 9.74 9.74 19.49 10.0% 0.066
9th 1.451 147.75 5% 5% 7.39 7.76 155.13 10.72 10.72 21.44 10.0% 0.069
10th 1.520 155.13 5% 5% 7.76 8.14 162.89 11.79 11.79 23.58 10.0% 0.072
79.7 79.7 159.4
Income Growth Factory # Shares at Start of Period Beginning Share Price Dividend Rate (Yield) Div Growth Rate Div Rate ($$) Per Share Next Year's Div Rate New Mkt Value in Anticipation of New Div Rate This Year's Div Income This Year's Cap Apprec. Anticipating Div Increase Total Return Total Return % New Shares Bought w/Reinvested Dividend
1st Yr 1 100 10% 0% 10 10 100 10 0 10 10.0% 0.100
2nd 1.10 100 10% 0% 10 10 100 11.00 0 11 10.00% 0.110
3rd 1.21 100 10% 0% 10 10 100 12.10 0 12.10 10.0% 0.121
4th 1.33 100 10% 0% 10 10 100 13.31 0 13.31 10.0% 0.133
5th 1.46 100 10% 0% 10 10 100 14.64 0 14.64 10.0% 0.146
6th 1.61 100 10% 0% 10 10 100 16.11 0 16.11 10.0% 0.161
7th 1.77 100 10% 0% 10 10 100 17.72 0 17.72 10.0% 0.177
8th 1.95 100 10% 0% 10 10 100 19.49 0 19.49 10.0% 0.195
9th 2.14 100 10% 0% 10 10 100 21.44 0 21.44 10.0% 0.214
10th 2.36 100 10% 0% 10 10 100 23.58 0 23.58 10.0% 0.236
159.4 0 159.4

Running these spreadsheets from time to time over the years to confirm what always seemed to be intuitively obvious, has been very interesting (and reassuring).

Each spreadsheet begins with 1 share of stock that has a market price of $100. It then calculates for each year what the cash dividend income will be and, if the dividend grows, what the new higher market price will be assuming the percentage yield remains the same. That rise in price is logged as the capital appreciation for that year and the total return for the year is the sum of that capital appreciation plus the cash dividend payment.

Then the cash dividend is reinvested in additional stock at the new market price and the whole process is repeated for the following year, with the amount of stock owned increased each year by the amount of the stock bought with the previous year's dividend.

You can plug in any combination of dividend yield and dividend growth that adds up to 10% and get the same total return, but obviously with different distributions between cash and capital appreciation. In fact, as long as the Income Factory and the DGI portfolio have similar total yield plus growth numbers (e.g. 8% for Income Growth and 4% and 4% for DGI) the total returns for both will be similar. (I will attach the link to the excel spreadsheets here in case anyone wishes to "repeat the experiment" or run their own numbers.

Final Thoughts

As I have said before, I am not knocking DGI as a valid and successful approach to long-term growth-oriented investing. I started out as a DGI investor. What finally convinced me to switch to high yield, "reinvest and compound" investing to achieve growth, was the angst of having to worry about, predict (which is pretty impossible) and then manage downturns.

Downturns can leave a lower yielding portfolio pretty dead in the water while you wait months or years for a turnaround. Meanwhile moving to the sidelines and sacrificing income waiting for downturns that never come carries an expensive opportunity cost. But for high-yielding income factory investors, downturns can be opportunities to accelerate your income growth.

My own personal results (see below) over the past 24 years reflect this. These show total return (cash received plus capital gain or loss) in the far right column, and also show the cash return in the middle column for as far back as my records show it. As you can see, I only embraced this higher yielding "income factory" strategy for my entire portfolio during the past five years or so, as you see the cash return rise from the 6-7% range (sort of a mixed DGI/Income Factory strategy) in 2010 and 2011 to a full-fledged Income Factory strategy (9-10% yields) by 2013-2014.

I did it in part because I saw firsthand how well high yielding investments did through the Great Crash of 2007-2008, where market prices cratered but the instruments themselves - like the Energizer Bunny - kept on generating cash that could be re-invested at absurdly low prices (50-60-70 cents on the dollar).

In recent years, my lowest total returns were in 2014 and 2015, with total returns of 3.8% and -5.7% respectively. But during those years when I was experiencing paper losses, I was still collecting over 10% in cash to re-invest and grow the income for future years. Any strategy looks good when you are making cash profits plus paper profits. But, ironically, it was the years of negative total return where I could grow my cash flow faster than ever, in spite of the paper losses, that really demonstrate the value of this strategy.


Cash Yield

Total Return


1994 -4.10%
1995 28.00%
1996 19.70%
1997 24.80%
1998 9.60%
1999 4.10%
2000 2.20%
2001 9.40%
2002 -0.60%
2003 25.20%
2004 16.20%
2005 6.00%
2006 14.90%
2007 1.72%
2008 -29.37%
2009 40.12%
2010 6.13% 18.91%
2011 7.31% 5.42%
2012 8.09% 16.42%
2013 9.12% 17.64%
2014 10.03% 3.80%
2015 10.57% -5.70%
2016 11.34% 21.01%
2017 8.95% 20.86% (9 months)

I realize this strategy is not what many of us - as investors or investment professionals - were brought up on over the past half century. I hope it has been helpful, interesting or thought-provoking. As always, I appreciate all the helpful ideas and analytical input from other Seeking Alpha authors, followers, readers and commenters.

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

Additional disclosure: Although I do not own the stocks mentioned in this article - Disney, GE, P&G, J&J, IBM - in the "Savvy Senior" IRA portfolio that I routinely write about, I do occasionally buy them into portfolios I manage informally for family members and close friends, where my strategy on their behalf follows less of a "pure" Income Factory approach than my own personal investing.