The Dividend Growth Strategy

LogoWhen they are at least fairly priced, I purchase certain common stocks with a long record of dividend growth and hold them for years, waiting for the dividend and the yield to grow. In the long run, yield provides most of the return. I also use yield, mainly, to determine value. A stock with a low yield and high dividend growth, for instance Tim Horton's, is expensive.

Here's an example. We bought 500 Fortis shares in 1995*, in two batches at an average price of $24.62 a share…some $12,300 in total. Ten years later (you have to have patience with this strategy), in the fall of 2005, Fortis shares split 4:1. This meant that the fine people with the A1 postal code (Fortis is an electrical utility essentially, based in St John's) mailed us a new 1,500 share certificate. In total, we now have 2,000 shares of Fortis. The stock split also meant our $24.62 purchase price became $6.16 (24.62 / 4). As I review this in February 2009 after the great bear market crash of 2008, the price of FTS is still close to $25…about what we paid for our 500 shares originally…before the split. Hence, our 2,000 shares are worth $25 times 2000 = $50,000.

With the stock price up that much, one might think of selling. Dividend growth people usually don't sell, though. Here's one reason I don't sell. Our cost price on these Fortis shares is $6.16. The dividend is now $1 a share per year, so, and it's a big SO, our Fortis shares now pay 16.9%1) on our original cost (1.04 / 6.16). Would you sell an investment the yields 17%. Or, you can work the return out this way: we have 2000 shares now. Our annual income from the Fortis shares is 2000 times $1.04 = $2,000 a year. We receive $2,000 from an investment of $12,300 ten years ago. Not bad, eh. In 2010, if Fortis increases its dividend again, and I expect it will (in 2008 the dividend increase was 10%), our income and our yield and our capital too will go up still more. Can you think of a better retirement asset? And notice, as the dividend has increased, our principal has too. It's double dipping. You get to have the cake (keep your capital and watch it grow) and eat it too (spend the growing dividends each year). Some people like to reinvest the dividend, but that and DRIPs are another topic. A friend of mine dropped dead last week: she was a year younger than I am. I spend my dividends. Some go to the Sick Kids Hospital Foundation…they looked after our grand daughter Julia for the first week of her life. © Connolly Report

2) Realize that the 16.9% is the yield. The 16.9% does not count capital gains.

* In early 1996, I thought Fortis was still a good buy, so we added to our position with another 500 shares. These common shares are also valued at $50,000. We have $100,000 in Fortis…just one stock in a portfolio of some 10 stocks. All, but one of our stocks, have done the much same thing. However, they are not all worth $100,000, so we are not millionaires…yet. Actually, after what happened in 2008 and early 2009, we are not even close to it any more, but our dividend income went up 9.8% in two zero zero eight. That's down from 12.2% in 2007, but a 9.8% rise in income in these conditions is nothing to frown at.

As I revise this item in January of 2008, however, Fortis is NOT value priced. FTS's current yield of 3.47% is about half a percentage point below its average yield of 3.93%. This is what I mean when I say I use yield to determine value: I compare the current yield of a stock to its own average yield. I use other indicators of value too (Graham's value, Price/Book and P/E), but more on value indicators elsewhere on this site.

As an aside, we also have shares in Cdn Utilities bought in 1987 and 1992. With dividend growth, our yield on cost is now 11.1%. We sold our Emera and TransAlta, two more electrical utilities, however, as the dividend growth was poor. Both EMA and TA increased their dividends in 2008: ship happens! as our son says. He's the CFO on a ship.

I would not want you to think I was cherry picking…using the best examples. Rob Carrick, writing in the Report on Business in September 2007, listed 20 'Dividend Deluxe' companies and included in his table the yield of these stocks ten years after purchase. Half of them had double digit yields (three banks and three from the Power group, for instance). Realize that we're talking yield alone. I'm not counting the price increase in these calculations. With dividend growth investing, after a few years (maybe a decade) of dividend growth, you can beat the market with yield alone. Price increases are the bonus. But…and it's a big but…do you have the patience to wait years for the dividend to grow? Can you control your behaviour and resist buying 'story stocks' which do not pay dividends? If you can, you'll be set for your retirement financing. And here's the big bonus: it will not matter if the market is down when you leave work. It's the income you'll be using. Delve into the dividend growth strategy. Learn more. This one-page PDF dividend growth example might help: YOC_BNS

Some general ideas on the essence of dividend growth investing: You must believe it produces superior returns. You must stay on track. You can't waiver. Study the evidence it works You must buy only common stocks and only common stocks that pay a dividends. And further, only common stocks with a good dividend growth record. There are only about 20 such Canadian stocks. Load up on them when they are fairly priced…certainly not all at once. Valuation of the stock at the time you buy is most important (value priced). How do you know if they are fairly priced? I use a couple of value measures: yield, Graham's price and the cyclically adjusted (ten-year) price to earnings ratio. It's the growing income you are after (not high yield) so you do not have to eat into capital when you retire. Mutual funds do not produce much income: they eat into your capital to pay you. It's the long term income your assets produce that is important. You do not want a fixed income, do you? Motivation: Once you've owned a dividend growth stock for a decade or so, you will most likely be beating the market with you income alone. You must be brave to take the first step. Once your portfolio is set up, it pretty well runs itself…benign neglect.

Look at dividend growth investing this way. You will end up receiving much more than the original yield (dividend/price). As the dollar amount of your dividend increases over the years, you can say you are earning an increasing dividend yield on your original invested capital (higher dividend/ original price).

I'll might add a bit here on what to do next . . .The Investment Zoo, for instance.

A company which pays dividends attracts institutional investors: it should attract you too.

  • Dividend growth drives price growth. Here's some evidence: dg_vs_g_07.pdf

WHY DON'T THEY: In November 2006, John Heinzl, in a telephone interview, asked me if the dividend growth strategy works so well, why don't more people follow it. Heinzl asks probing questions which is why his columns are so good. After I got off the telephone and I thought about it, I e-mailed him my list of reasons. People don't know it works, most don't have the discipline needed to execute the strategy, they can't wait for the results (it takes years for yields to build), yields start low, story stocks lead them astray, the method is dull and boring, they fear doing it on their own, they feel they need help (a broker even), they don't believe they can do better. After thought: they have been lead astray by a financial planner.

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dividend_growth_strategy.txt · Last modified: 2014/03/15 08:06 by tom
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