What does Dividend Growth Investing Really Mean?

The meaning of the term “dividend growth investing” (DGI) has become extremely varied. Given its wide usage, one can’t assume any particular strategy is referenced whenever the term is used.

Most practitioners actually are engaged in a dividend-based income strategy, and the growth part of dividend growth investing has been minimized. Thus, it might be helpful to review some of the more popular versions of the term “dividend growth investing” and compare it to the principles, goals and metrics used by our Model Portfolio, which will be presented in part 2 of this article (to be posted: tomorrow on December 31st).

Introduction

The amount of variation in the meaning of DGI is truly astounding. When one reads analytical reviews of income strategies, market commentaries, fund marketing material, or even reviews by other practitioners of dividend growth investing, there is never any clarity about the exact nature of the portfolios, how companies are chosen nor any data about how the portfolios are performing.

Because of this lack of definitive referential meaning, it would be useful to outline some of the ways the term “dividend growth investing” is being used today. Then, this range of usage could be compared to the goals, metrics, and variables that are used by our Model Portfolio.

This comparison would, in turn, help define what the Model Portfolio represents compared to all of the modern discussions available in financial literature and on the internet.

History

From 1985 to 2003, dividends were taxed at whatever the individual’s tax rate happened to be. The “Bush tax cuts” of 2003 lowered these tax rates to 15%, or even to 0% for those whose tax rate was 15% or lower.

These rates lasted until 2012, when the dividends of those making more than $400,000.00 began to be taxed at 20%. These lowered rates applied to “qualified” dividends which are those paid by corporations listed on a major US exchange. To get exact details about the taxation of dividends, IRS Publication 17, Chapter 8 makes for great bedtime reading 😉.

The Bush tax cuts regarding dividends unleashed a torrent of interest in investment strategies based on these tax advantages. The mutual fund industry began to offer funds oriented to companies that paid dividends, the bigger and more reliable the better. Some funds emphasized the growth of dividends, and the idea of dividend growth investing became very common in the investment world.

Variations on this theme proliferated. Exchange traded funds (ETFs) took up the theme and replicated many of the mutual funds. In 2015, there were over 200 funds and ETFs with “dividend” or “dividend growth” in their name.

Lists of Dividend Payers and Indices

Moody’s published the first “Handbook of Dividend Achievers” in 1977, initially a listing of companies that had paid an increasing dividend for the last 10 years. In 1983, Moody’s information services division was sold to Mergent, which continued the handbook. Mergent was known for its dividend handbook for many years.

In 2003 and 2004, in response to the tax cuts for dividends, Standard & Poors (S&P) created their own listings of dividend payers, and DowJones followed close behind. All of them introduced families of index products based on dividends. These listings were organized in multiple ways across geographic regions, and varied by different dividend metrics.

As a result, there arose hundreds of funds that are based on these indexes. Investing in most of these funds was originally seen as simply “dividend investing” while emphasizing the tax advantages of this type of income. The “growth” part of dividend growth investing was not emphasized, or it was an afterthought or simply not significant. No mutual fund reports the growth of dividend income as a metric that can be used by investors.

DRIP Investing and the “CCC” Lists

In the early 80’s, a form of personal investing that involved purchasing shares directly from companies and reinvesting dividends through the company became known as DRIP investing (Dividend Reinvestment Programs). DRIPs were promoted by AAII and by Moneypaper, Inc. DRIP investing was oriented to small long-term investors, and was very popular.

The current executive editor of Moneypaper is David Fish, who created a private listing of US traded dividend payers; composed of (1) dividend champions that had at least 25 years of consecutive dividend increases; (2) dividend contenders that had 10 years; and (3) dividend challengers that had more than 5, but less than 10 years of consecutive dividend increases. These listings are known as the “CCC” listings, and differ significantly from some of the listings by the major index platforms.

The CCC listings, along with lots of other data can be found here. As of June, 2015, there were 111 Champions, 257 Contenders, and 372 Challengers on these CCC listings. It should be noted that the CCC lists do not make any attempt to cover major foreign firms that are not listed on a major US exchange.

Internet Forums for Dividend Investing

Seeking Alpha (SA) is one of the largest internet platforms that consists of contributors who write on a range of financial and investment topics. It was launched in 2004.

Seeking Alpha developed a separate section for “dividends and income” in 2010 that has evolved into a large online forum of financial firms and individuals interested in dividend growth investing. Each day, there are about 20 articles on various aspects of dividend paying companies.

Screening and Scoring

There are two basic approaches to picking stocks. Of course, there are thousands of other ways to pick stocks (throw a dart at a newspaper), but screening and scoring are popular systematic ways to select superior companies.

Screening. An investor can use a software program or an online subscription service to use a custom set of variables that are then used either jointly or in sequence to select stocks that meet or exceed values on these variables.

For example, one may want to look only at stocks that have a 10-year dividend growth record of >7%. Then, out of this group, one may decide to consider only those that have a BBB+ credit rating, and so forth.

Scoring. When a scoring approach is used, a group of metrics or variables are reviewed or measured, and then the company is given a score that reflects the extent to which the company meets a high level on each metric or variable.

For example, if debt ratios are being reviewed, scores may be assigned such that low debt to equity ratios get a high score, and as these ratios go up, the company gets a lower and lower score. Such scoring can be applied to any number of variables to get a composite or total score for a particular company. These scores are really just a ranking based on the judgments of each analyst.

Most analysts and financial journalists use some combination of screening and scoring. In general, scoring methods are preferable because in that case, a single very bad metric will not eliminate a company which may score high on many other variables.

In the case where one has certain minimum requirements for accepting a stock into a portfolio, candidates will be screened for meeting such requirements. Minimum requirements are discussed in part 2.

Continue to Part 2

There are many additional categories whereby dividend growth investors will vary, and still claim to be engaged in DGI. One of these is the universe of companies that serves as the starting point or basis for selecting stocks. Another is the set of preconditions, if any, that a stock must meet in order to be considered for inclusion in the portfolio.

Part 2 will discuss these topics, along with a general guide to the most popular variables that are used to select companies. All of this will be compared to what rules are used by our Model Portfolio.

Thank you for reading and stay tuned for part 2, which will be released tomorrow!

See this post on our blog.

---

---

Answer the QOTD for an upvote in the comments below!

A friend recommended that we try giving out rewards via upvotes in the comments to all those who answer the QOTD. We're doing this in hopes to increase engagement and encourage the sharing of knowledge/experience with each other in the comments! Let us know what you think of this program and if you have any suggestions to improve it!

QOTD:

1. What is the difference between a screening system and a scoring system when it comes to selecting dividend stocks?