I think that dividend growth (NYSE:DG) investing is solid income strategy but there are at least 2 caveats:
- some companies cut or even omit dividends;
- dividend growth rate for a company declines with time (due to a company life cycle - see e.g. www.productiveflourishing.com/the-busine.../).
In this note I investigate it robustness to 2 factors outlined above.
Academic studies (see results review in seekingalpha.com/instablog/725729-sds-se...) show that in average about 3% of companies with stable or growing (during previous 5-7 years) dividends cut them. Of course, more payers reduced or omitted dividends during ~1930 and ~ 2008 depressions but 3% seems reasonable number.
Long history of actively managed index S&P500 (which populated with new growing companies and dumped out from badly performed companies) shows that average dividend change rate (DCR) is about +5%.
I mimic both factors for passive portfolio in a simple exercise. I presume that absolutely passive DG investor ("buy-and forget" type of behavior) forms portfolio with initial average 3% yield on cost (YoC). The portfolio has DCR = 5% during 1st year of investing and then DCR gradually decreases (to less than 1.5% after 50 years) but always positive, for sake of simplicity I just increase yield on 0.15% annually. These numbers are at least very modest for any realistic DG portfolio but I presume zero inflation in this example. Analysis of David Fish Dividend CCC list (fig. 1) shows that DCR decreases with time of an average company's dividend payments.
I assume worst and almost worst case scenarios:
1) investor loses all money invested in a company that cut or suspend dividends, i.e. the company's stock is delisted immediately.
2) investor loses 50% of money invested in company that cut or suspend dividends and uses the second half for purchase stock of another company with positive DCR.
I'd like to point that it is NOT always wise to sell stock because a company cut dividends (see "Don't panic if dividends were cut" in my instablog seekingalpha.com/instablog/725729-sds-se...) but many DG investors consider such event as sell trigger. So number of "dividend cows" in portfolio of such investors decreases with time.
Results are shown in fig. 2 plotted from numbers in the table (fig. 3).
Even in the 2nd almost worst case DG investor will see income increase in the first 30 years after the passive portfolio formation from remaining dividend growth companies with decaying positive DCRs. Not so fast DCR decay or smaller average loss of stock price after dividend cut lead to longer period of DG investment robustness.
Added 17 Jan 2014:
Prof. B. Cornell in 2012 Working Paper "Dividend-Price Ratios and Stock Returns: Another Look at History" shows that, ex-post, long-run real dividend growth never changes - it mirrors long-run real GDP
growth at about 3% per year in USA (see picture above). So economy probably an important factor for DGI.