Coming To Terms With Dividend Growth

by: Adam Aloisi

About six months ago I wrote an article providing a critique of the dividend growth strategy and identified reasons why I was somewhat skeptical of it. Upon reflection, I've come to the realization that my thoughts were prejudiced by my own strategy and a misguided assumption that all investors would benefit by thinking in terms of total return, like me.

While I've been thinking I was a bit prejudiced in that article for some time, it was David Van Knapp's recent article discussing MPT and DG that hit home. In it Van Knapp discusses the "absolutist nature of MPT," an assessment and observation that I saw staring me in the mirror. In hindsight, I wish I had not written some of the things I did.

Though my admission doesn't mean that I'm abandoning my total return strategy, it does mean that I feel as if I erred in criticizing pure dividend strategies to the extent I did. If long-term, patient stock ownership and a stream of income is one's goal, why not root for lower prices and higher yield entry points along the way? If income, and not capital growth, is paramount, then it's understandable that adherents exhibit a certain level of apathy toward stock price. It's not how I necessarily put two and two together, but then two and two isn't necessarily the easiest, best, or most appropriate route for everyone to get to four.

Is Dividend Growth A Superior Strategy?

Despite my admitted past bias, I still have some doubt about a pure dividend strategy. I continue to read articles that either subjectively claim, infer, or attempt to illustrate that in and of themselves dividend payers are a preferable group of stocks to own over the long haul. Further, one author posed the thesis that when comparing two companies with almost identical growth characteristics, the one paying a dividend provided a "bonus" to investors versus the non-dividend-payer.

While these analyses are often interesting, educational, and entertaining, I remain unconvinced that DG is subjectively "better" than total return for a younger investor. I do, however, consider DG an ideal approach for near- or in- retirement investors and would anticipate that as I continue to age, my focus will shift more or perhaps entirely towards dividend growth.

Portfolio performance really comes down to security selection, not strategy in my view. It's easy to visualize how a lousy growth stock picker will underperform a skilled dividend investor with good timing and portfolio management, and vice versa. However, it's impossible for one to say that a total return portfolio will perform better than a portfolio composed entirely of dividend paying stocks over the next ten years.

The bottom line for me is that no strategy offers a fullproof solution for each investing need or goal. Independent investors need to evaluate personal situations and find a strategy or blend of strategies that mesh with individual risk tolerances and provide opportunity to achieve varied objectives. Once a desired strategy is defined and implementation begins, success or failure is predicated on the fate of individual security selection.

Dividends As Part of My Solution

As a total return investor, I've always considered myself flexible, open to including many schools of thought in my portfolio. It's been my belief that keeping options open to just about any security under the sun was the best policy. Dividend growth however, has educated me that sometimes for investors with specific targeted goals, having a more focused strategy affords a blend of manageability, simplicity, and practicality not existent in a more open strategy.

Despite my continued aversion to adopt or advocate a pure dividend strategy, I am finding that dividends and dividend analysis are becoming a more implicit part of my due diligence and investing repertoire. Take for example my recent purchase of Target (NYSE:TGT). Though the company first came on to my radar in May because of its valuation and sales trends, its announcement to aggressively return cash to investors in the years ahead was a key component of my decision in June to take a position.

Target's low payout ratio, a statistic that I paid little attention to prior to reading about the DG strategy, was a data point that I focused on during my due diligence. Currently below 30%, it provides plenty of room for the company to expand payouts, consistent with its recent announcement. Coupled with the forward earnings growth I anticipate, Target provides for an excellent total return opportunity.

Cisco's (NASDAQ:CSCO) recent earnings release and eyebrow raising 75% dividend increase plus added commitment to boost the payout in the years ahead put this perennial underperformer on my radar for the first time in over a decade. While I haven't bought shares and am still skeptical of the company's earnings growth, Cisco's dividend pledge is a data point on which to develop or further an investment thesis. With a yield in the 3% range and low payout ratio, it, like Target, is an interesting total return idea going forward.

Finally, though I have held other dividend and dividend growth stocks for their total return promise in my portfolio for many years including Phillip Morris (NYSE:PM), Diageo (NYSE:DEO), Conoco (NYSE:COP), Disney (NYSE:DIS), Lockheed (NYSE:LMT), and General Electric (NYSE:GE), I can honestly say a greater understanding of dividend analysis will improve my ability to scrutinize these positions. Dividend policy may not be the primary focus that initially prompts a buy or sell decision for total return investors, but in-depth understanding of corporate payouts seems a critical aspect of the equity-income portion of total return.

Whether dividends serve as the hallmark of your portfolio or not, I feel there's a fundamental benefit to expanding one's understanding of corporate payouts. I'm not sure if my article earlier in the year suffered from a bit of pomposity or perhaps ignorance (maybe both), but in either case I felt inclined to write this clarification of my position. Perhaps it is possible to teach an old dog new tricks.

Disclosure: I am long TGT, COP, GE, LMT, DEO, PM, DIS. 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.