Dividend growth companies are attractive to investors because they, by definition, get a larger payment every year. And that could mean huge passive income potential, right Unfortunately, it’s not that simple. Dividend growth investing can work for some investors, but not all dividend growth stocks are created equal. Here are some things to be aware of.

 

1. Don’t be lured by just a high yield–share price growth matters.

Many of the best dividend growth stocks don’t have high yields. Let that sink in for a moment.

Consider this: when a company pays out a dividend, that’s not free money. On the contrary, it’s less money that goes back into the company which can slow growth down.

In fact, high yield could be a sign that there isn’t much growth to be had at all. Management, for example, might not believe there is an upside to putting funds back in the company, so they instead send extra money to shareholders.

Relatedly, yield can actually hide negative growth. Yield, after all, is the dividend per share divided by the stock price.

For example: say Stock A is worth $20 per share and pays an annual dividend per share of $2. Next year, the price decreases to $15, but it maintains its $2 annual dividend per share. Stock A’s dividend yield jumped from 10% to 13.3%. Yet, the company became less valuable (and so did your investment).

Rather than laser-focusing on the lure of yields, take a step back and consider if the share price displays any promise of growth. Whether it does (or doesn’t), this holistic view can help you decide more strategically on how to approach your dividend growth options.

 

2. Many of the best dividend growth opportunities don’t have high yields.

Past data shows that low yields tend to beat out high yields in terms of dividend growth. Companies like Coca-Cola and 3M have consistently raised their dividends every year for over half a century. In this respect, the low-yield tortoise can beat the high-yield hare if that aligns with your investment goals.

For example, if you’re an investor only looking at high yield dividends, AT&T offers a 7.3% yield. However, they’ve struggled over the last 5 years, with their investors losing 35% that could have been invested elsewhere.

On the flip side, Walmart offers a 1.5% yield (which is on the low side) but over the last 5 years, its total return has been 95%. Even though it’s a significantly smaller dividend when compared to AT&T, it’s difficult to argue that a nearly 100% return rate wouldn’t be a good investment despite a low yield.

There’s no doubt that it can be a safer bet to go with companies that have a long track record of increasing their dividends. These blue chip companies have made it through all types of market conditions and economic circumstances, but still boosted the dividend without fail. Over the long term, there’s a higher chance of earning a larger total amount in dividends.

 

3. Look for durability–a long track of increases is more important than either a dividend initiation or a large, one-time increase.

Durability takes precedence over immediacy. A longer track record of consistent dividends and dividend growth offers more proof that the dividend is likely (not guaranteed) to continue to increase in the future.

This is most obvious when it comes to stocks that are trying to enter the dividend world. They have no track record of operating successfully while paying dividends, so you don’t have any dividend data to look at. They might end up being a great dividend growth stock—or they could cut their dividend next year.

Now, there’s another thing to watch out for: large, one-time increases.

A company may do this to lure in more investors, or they might simply not see much growth potential should they reinvest this larger-than-usual amount. Either way, a company can only consistently raise dividends if it increases its earnings! So buyers beware.

Companies that have a track record of consistently raising their dividend over the long term have likely weathered many financial storms without cutting their dividend and this could be a potential indicator of a great investment.

 

4. The cash flow from a solid dividend growth company should meet or exceed inflation over time.

Many think about inflation only when their cash is sitting in a bank account. But when it comes to dividend investing, you need to ensure your dividend growth cash flows are beating inflation as well.

To illustrate, say you earn $100 in dividends this year. Next year, consumer prices go up by 2%. Items that used to cost $100 are now $102. If your dividend holdings don’t increase their dividend to pay you at least $102—ideally more—then you’re losing money.

So, you might think you’ve found a solid dividend growth company to add to your portfolio, but before you consider doing so, make sure their dividend payment has consistently beaten inflation.

 

Is Dividend Growth Investing Right For You?

Dividend growth investing can be a good strategy in the right context, but the right strategy is more nuanced than one might be led to believe. Want to know, for sure, what type of investing is the smart play for you? That’s why we’re here. Monument Wealth Management is a boutique wealth management firm that delivers clarity at every stage of your wealth journey.

Our Team collaborates with you to co-create your very own wealth strategy –taking into consideration your big picture and showing you how to meet your goals using what we know today, while adapting to the unforeseen changes of tomorrow. Whether you need help understanding dividend growth investing, want to make sure your current portfolio is set to support your life goals, or you’re ready to plan for the future, we’re here for it.