Dividend growth stocks are an excellent vehicle to build passive income over time. The idea of owning businesses that pay you more money year after year has a certain appeal to those in pursuit of passive income. Not only do dividend growth stocks give you a raise year after year, they have also historically outperformed the market. The Dividend Aristocrat Index is made up of businesses that have raised their dividends for 25+ consecutive years. The Dividend Aristocrat index has outperformed the S&P500 by 2.41 percentage points per year over the last decade.
Source: S&P500 Dividend Aristocrats Fact Sheet
Dividend Aristocrats & Quality
The Dividend Aristocrat index is full of high quality businesses with a long history of success. Some examples are Coca-Cola (KO), Wal-Mart (WMT), PepsiCo (PEP), 3M (MMM), and Johnson & Johnson (JNJ). There are 54 businesses in the Dividend Aristocrats Index. You can download a full list of current Dividend Aristocrats sorted by dividend yield, growth rate, and P/E ratio right here. Not only do Dividend Aristocrats have a long history of profitable growth, they also tend to have higher profitability on average. The average return on assets (ROA) for the S&P500 is 7.23%, compared to 9.58% for the average Dividend Aristocrat stock.
High Yield & Low Payout Historically Outperform
You would likely do quite well to invest in Dividend Aristocrat stocks. Not all Dividend Aristocrats are created equally, however. The higher the dividend yield, the better within reason. A company with a high yield and a high payout ratio will have very little earnings to reinvest in growing the business. Businesses with high dividend yields and low payout ratios have historically performed very well. In a study done by Credit Suisse, high yield low payout stocks outperformed high yield high payout stocks by 8.2 percentage points per year from 1990 to 2006.
Source: High Yield, Low Payout by Barefoot, Patel, & Yao
Don’t Forget the Growth in Dividend Growth Investing
Aside from yield and payout ratio, future growth potential is an important aspect of successful long-term dividend growth investing. If you invest in a business with poor growth prospects, your dividend payments will stagnate and may decline over time. Once again, facts back up common sense. Dividend growth stocks have outperformed dividend stocks with unchanging dividends by 2.4% per year from 1972 to 2013.
Source: Rising Dividends Fund Research from Oppenheimer
Buy the Business, Not the Stock
High quality dividend growth investing requires a specific mindset. Dividend growth investing is most suitable for long term investors. Dividend growth stock prices fluctuate from year to year. Over long periods of time, truly superior businesses that can grow their earnings and dividends year after year will reward shareholders. If you view your investments as electronic bets that may go up and down, you will quickly be shaken out of your positions.
High quality businesses take years to compound growth. If you view your investments as a partnership in large businesses you will likely foster a long-term outlook. Understanding that you own a percentage of a fantastic business makes you less likely to sell as the share price bounces around because you understand the underlying value of your investment instead of seeing it as a ticker symbol in a trading account.
Sure Dividend’s 8 Rules of Dividend Investing combines several of the criteria above to find high quality businesses trading at fair or better prices that have a long history of rewarding shareholders through dividend increases. Examples of highly ranked businesses include:
- Coca-Cola (KO)
- Abbott Laboratoires (ABT)
- General Mills (GIS)
- J.M.Smucker's (SJM)
Investing in high quality dividend growth stocks is an excellent way to generate a passive income stream that grows over time. Historical financial studies show that dividend growth investing has not only been profitable, it has outperformed the market in the past. Dividend growth investing requires a long-term outlook and a bit of research to find stocks with durable competitive advantages. The Dividend Aristocrats Index is an excellent place to begin looking for high quality dividend growth stocks.