Imagine planting a small sapling in your backyard that produces a handful of dollar bills in its first year. But here’s the magic. Every year, not only does the tree grow taller, but each branch also becomes more fruitful. In the world of investing, planting this type of money tree is called dividend growth investing.
Dividend growth is just a fancy way to refer to a company that shares its profits with you (dividends) and increases those payments each year (growth). This is a powerful combination of attributes in the stock market, as it’s pretty hard to do both. If a company wants to grow, it usually doesn’t pay out dividends. If it wants to pay out dividends, it usually doesn’t reinvest enough capital to grow. So if you can spot dividend growth stars early, you get the best of both worlds: income and appreciation.
Now, you might be thinking, “This sounds too good to be true. What’s the catch?” Well, there’s no catch, but there are trade-offs. For example, dividend growth stocks aren’t going to match the sheer explosiveness of pure growth stocks. So if your goal is maximizing returns from major trends, you’re better off with a strategy like thematic investing.
Instead, dividend growth investing is all about unwavering, compounding growth over time. It’s the difference between betting on a racehorse and nurturing an orchard. One might make you rich overnight, but the other provides fresh apples (or in this case, cash) year after year. In this guide, we’ll walk you through everything you need to know to start planting your very own money tree.
How Dividends Work
Before we get to the nitty gritty of dividend growth investing, let’s make sure we’re all on the same page about what dividends actually are.
What Are Dividends?
In the simplest terms, dividends are a slice of a company’s profits (a.k.a net income or earnings) that it splits with its shareholders. This is what remains after all operating expenses, interest, and taxes have been deducted from a company’s revenues. It’s the “bottom line.”
If a company decides to pay out dividends, it basically takes a portion of its total profit and then divides it by the number of shares outstanding. The size of your slice of the pie is directly proportional to the number of shares you own.
Types of Dividends
Just as trees can bear different kinds of fruit, companies can pay out different types of dividends:
- Cash Dividends: The most common type. It’s exactly what it sounds like – cold, hard cash deposited straight into your account.
- Stock Dividends: Instead of cash, the company gives you more shares of stock. It’s like your money tree sprouting new branches that will bear even more fruit in the future.
- Special Dividends: These are one-time payments, often larger than regular dividends. Think of them as a bumper crop – a nice bonus, but not something you should count on regularly.
Dividend growth investors usually prefer cash over stock dividends. Cash gives you more control over reinvestment decisions.You can reinvest in the same company, diversify into other stocks, or just grab the new iPhone — the choice would be yours.
That said, stock dividends have their advantages too. While not as flexible as cash, they can be more tax-efficient, as taxes are typically deferred until you sell the shares. They also allow you to be more hands-off if your goal is to increase your ownership in the company.
How Dividends Are Paid
Dividend payments are typically made quarterly, though some companies pay monthly or annually. The dividend payout flow involves a few key dates:
- Declaration Date: The company announces, “Hey everyone, we’re going to pay a dividend!”
- Ex-Dividend Date: This is the cut-off date. If you buy the stock before this date, you’ll receive the upcoming dividend. If you buy on or after this date, the seller gets the dividend.
- Record Date: The company checks its books to see who owns shares and is entitled to the dividend.
- Payment Date: It’s time to pay up. This is when the dividend actually hits your account.
Pro tip: Most brokers these days automatically reinvest your dividends for you (unless you tell them not to). This means your dividends are used to buy fractional shares of the same stock. Then, in the next dividend cycle, your slice of the pie gets even bigger. Yes, we’re talking about juicy compound growth.
Dividend Growth: The Strategy’s Secret Sauce
Imagine you bought shares of two fictional companies 10 years ago. Both were paying a $1 dividend per share at the time:
- SteadyCo has kept its dividend steady at $1 per share for the past decade.
- GrowCo has increased its dividend by a modest 7% each year.
Today, Company A is still paying you $1 per share. But Company B? They’re now paying you $1.97 per share ($1 x 1.07^10). Your income has nearly doubled without you lifting a finger… not bad, right?
The Compounding Effect
But here’s where things get really exciting. When you reinvest those dividends, you create a powerful compounding effect. Not only is your payout per share growing thanks to the company’s efforts, but so is your total number of shares thanks to your own reinvestments.
The company pays you dividends based on how many shares you own… you use those dividends to buy more shares… which generate even more dividends next time around… and repeat and repeat. It’s a virtuous cycle of exponential growth.
Case Study: SteadyCo vs. GrowCo
Let’s say we started with an investment of $1,000 in both SteadyCo and GrowCo. They were both at $25 per share, with a 4% dividend yield.
| Initial Conditions | SteadyCo | GrowCo |
|---|---|---|
| Initial Investment | $1,000 | $1,000 |
| Initial Share Price | $25 | $25 |
| Initial Shares | 40 | 40 |
| Initial Annual Dividends/Share | $1 (4% yield) | $1 (4% yield) |
After 10 years:
| After 10 Years | SteadyCo | GrowCo |
|---|---|---|
| Dividend Growth (Past 10 Yrs) | 0% per year | 7% per year |
| Annual Dividend Per Share | Still $1.00 | $1.97 |
| Total Dividends Received | $400 ($40 per year x 10 years) | $558 |
| Extra Shares If Reinvested | 16 | 22.65 (assuming share price grew with dividends) |
| Total Shares | 56 (40 + 16) | 62.65 (40 + 22.65) |
| Value of Investment | $1,400 (56 shares x $25) | $1,730 (62.65 shares x $27.61 share price) |
| New Annual Payout | $56 (56 shares x $1 dividends) | $123.42 (62.65 shares x $1.97 dividends) |
After 10 years, GrowCo is paying out more than double SteadyCo. While SteadyCo shareholders are receiving $56 in yearly dividends, GrowCo shareholders get $123.42. That’s 120% more cash in your pocket each year. That’s also the same pay growth as eight promotions at your job (based on U.S. averages)… all without doing any extra work!
The gap in payments will only keep widening with time. At the 20 year mark, it will be $80 per year (SteadyCo) vs. $379.60 per year (GrowCo). And at the 30 year mark, it will be $120 per year (SteadyCo) vs. $1,247.63 per year (GrowCo).
Yes, after 30 years, GrowCo will be paying out over 10 times as much as SteadyCo annually. That’s like getting an extra 24 promotions at your job. It would be the difference between ending your career as the company’s CEO versus plateauing barely above entry level.
This is the power of compound growth.
Examples of Dividend Growth Stocks
Let’s look at some concrete examples in the real world. Dividend growth stocks can appear in all kinds of sectors, with a variety of business models. For example:
Microsoft (MSFT) has increased its dividend for 18 consecutive years, with a 5-year dividend growth rate of about 10%. The company has successfully shifted from traditional software to cloud computing while maintaining strong dividend growth.
Visa (V) has raised its dividend for 14 straight years, with a 5-year dividend growth rate of approximately 17%. The company’s position in the growing digital payments market has supported its consistent dividend increases.
Starbucks (SBUX) has grown its dividend for 12 consecutive years, with a 5-year dividend growth rate of around 14%. Despite operating in a competitive industry, Starbucks has used its brand strength and global expansion to sustain dividend growth.
Texas Instruments (TXN) has increased its dividend for 19 years in a row, with a 5-year dividend growth rate of about 17%. This consistent performance is notable in the often volatile semiconductor industry.
Home Depot (HD) has raised its dividend for 13 consecutive years, with a 5-year dividend growth rate of approximately 18%. The company has benefited from housing market trends and increased home improvement activities.
UnitedHealth Group (UNH) has increased its dividend for 13 straight years, with a 5-year dividend growth rate of around 18%. As a major healthcare company, UnitedHealth demonstrates how dividend growth can align with broader economic trends.
Dividend Aristocrats and Kings
In the world of dividend growth investing, some companies have achieved legendary status:
- Dividend Aristocrats: These are S&P 500 companies that have increased their dividends for at least 25 consecutive years. They’re like the seasoned oak trees of the investing world – sturdy, reliable, and consistently fruitful. (Full List of Dividend Aristocrats)
- Dividend Kings: Even more impressive, these companies have increased their dividends for 50+ years straight. Think of them as the ancient redwoods of the stock market – they’ve weathered countless storms yet still keep growing. (Full List of Dividend Kings)
Companies like Johnson & Johnson, Coca-Cola, and Procter & Gamble are among these dividend royalty. They’ve been raising their dividends year after year, through recessions, market crashes, and global pandemics.
Finding Future Dividend Aristocrats: What to Look For
One common theme that you’ll see among dividend growth investors is the desire to find the next aristocrats and kings. That’s because finding even a single one early can set your portfolio up for life.
While it’s impossible to perfectly predict who becomes a dividend aristocrat, some metrics give us good clues. These metrics help you dramatically cut down the universe of potential stocks to consider. However, note that it will be rare to find all of the following metrics in one stock, you’ll likely need to make some tradeoffs.
| What to Look For | Why It’s Important | Target |
|---|---|---|
| Consistent Dividend Growth | Past actions often indicates future plans. Companies that have consistently raised dividends are more likely to continue doing so. | Look for 5-10 years of consecutive dividend increases. In a stock screener, set “Years of Dividend Growth” > 5. |
| Low Payout Ratio | A lower payout ratio (total dividends paid relative to total net income) indicates the company has room to grow dividends even if earnings stagnate temporarily. | Generally, look for payout ratios < 60% for most industries. For utilities and REITs, < 80% is acceptable. In a screener, set “Payout Ratio” < 60. |
| Strong Free Cash Flow | Free cash flow represents the cash a company can use to pay dividends after covering all expenses and investments. | Look for a free cash flow yield (FCF/Market Cap) > dividend yield. This ensures the dividend is well-covered. Set “FCF Yield” > “Dividend Yield” in your screener. |
| Competitive Advantage | Companies with strong moats can maintain profitability over long periods, supporting consistent dividend growth. | This is more qualitative, but you can look for high and stable profit margins. Set “5-year average Operating Margin” > 15%. |
| Growing Earnings | Long-term dividend growth is impossible without earnings growth to support it. | Look for earnings per share (EPS) growth rates higher than inflation. Set “5-year EPS Growth Rate” > 5%. |
| Healthy Balance Sheet | Companies with low debt can better weather economic downturns and maintain dividends. | Look for Debt-to-Equity ratios < 2 for most industries (lower for capital-intensive industries). Set “Debt/Equity” < 2. |
| Management Commitment | Companies that prioritize dividends are more likely to maintain them even in tough times. | This is qualitative, but you can look for companies where insiders own a significant portion of shares. Set “Insider Ownership” > 5%. |
| Industry Trends | Companies in growing industries have more opportunities to increase earnings and dividends. | This is more qualitative, but you can look at industry-wide growth rates. Focus on industries with projected growth rates > GDP growth. |
| Reasonable Valuation | Overpaying can negate the benefits of dividend growth. | Look for P/E ratios below the industry average or the stock’s own historical average. You might set “P/E Ratio” < “Industry Average P/E”. |
| International Expansion Potential | Companies with global growth potential have more avenues to increase earnings and support dividend growth. | This is qualitative, but you can look at the percentage of revenue from international markets. Set “International Revenue %” > 30% for companies not already global. |
Again, don’t worry if you can’t find all of these targets in one company, or if your stock screener doesn’t support one or more of these screens. Market conditions change all the time, and this list is not meant to be a silver bullet. Instead, treat this list as your training wheels – use it to get your bearings, but expect to outgrow it as you become more experienced as a dividend growth investor.
Also, even if you do find all of these targets in one company, that doesn’t mean you should automatically go all in. Each company should still be evaluated on its own merits.
Three Major Pitfalls to Avoid
Before you embark on your dividend growth investing journey, let’s make sure you avoid three major pitfalls that newcomers often make.
Chasing Yield Without Considering Fundamentals
It’s easy to get stars in your eyes when you see a stock with a double-digit dividend yield. After all, who wouldn’t want to earn 10% or more on their investment right off the bat? But here’s the catch: abnormally high yields are often a red flag, not an opportunity.
Dividend yield is calculated by dividing the annual dividend by the current stock price. That means yield can be high for two reasons:
- The company is paying out an unusually large portion of its earnings as dividends (good, right?)
- The stock price has recently taken a nosedive (uh-oh)
More often than not, it’s the latter. A plummeting stock price could indicate that the market expects the company to cut its dividend soon. Or worse, it could signal deeper problems with the company’s business model or financial health.
A healthy company with a 3% yield and steady 7% annual dividend increases is much better than a shaky 10% yield company on the brink of collapse. So instead of chasing yield alone, consider the company’s fundamentals:
- Is the payout ratio sustainable?
- Does the company have a history of consistent earnings growth?
- How’s the balance sheet looking? Is there too much debt?
- Has the company been able to raise its dividend consistently over time?
Now, if you’re a beginner to the stock market, you might not be able to decipher all these on your own. That’s perfectly fine! The good news is that these companies tend to have plenty of analyst coverage. Someone else has probably already run the numbers— you just gotta know what to pay attention to.
Neglecting to Reinvest Dividends, Especially Early On
We’ve talked about the power of compound growth, but it’s worth emphasizing again: reinvest your dividends. In the early years of your investing journey, it can hugely boost your long-term returns.
It’s tempting to take those dividend payments as cash, especially when you’re just starting out and the amounts seem small. An extra $20 or $50 per quarter might not seem like much, but reinvesting that money can make a huge difference over time.
Let’s revisit our GrowCo example from earlier. After 30 years, reinvesting dividends resulted in 162.03 shares worth $6,626. But if you hadn’t reinvested those dividends, you’d still have your original 40 shares, worth just $1,635. That’s a difference of nearly $5,000. So unless you absolutely need the income now, strongly consider reinvesting those dividends. Your future self will thank you.
Failing to Diversify
Don’t put all your eggs in one basket – or all your seeds in one plot! Diversification is crucial in any investment strategy, but especially in dividend growth investing. That’s because, for the most part, we’re sector agnostic. We want great dividends that grow over time, so we want to avoid any one sector or industry dragging us down.
Consider spreading your investments across:
- Different sectors (don’t just stick to traditional dividend payers like utilities)
- Various company sizes (mix large caps with some promising mid-caps)
- Geographic regions (consider international dividend growers too)
- Dividend growth rates (blend steady growers with more aggressive dividend raisers)
Proper diversification helps mitigate risk and increases your chances of steady dividend growth.
Does Dividend Growth Investing Still Work Today?
It’s a fair question: in an era of high-flying tech stocks, is dividend growth investing still worth it? The short answer is yes, and here’s why.
First, dividend growth is a great proxy for strong fundamentals. Companies that steadily grow their dividends tend to be profitable businesses with strong cash flows. These characteristics never go out of style. Especially in times of uncertainty, these “reliable” companies become even more appealing.
But what about the argument that “this time it’s different”? Sure, we’re in an age of rapid change and disruption. But dividend growth stars are still adapting and evolving. Take Microsoft, for instance. Once seen as a stodgy old tech company, it’s now a cloud computing powerhouse that’s been growing its dividend for 20+ years straight.
Moreover, the power of compounding – the engine that drives dividend growth investing – is a mathematical certainty. Mathematical certainties do not change with market trends. Einstein called compound interest the “eighth wonder of the world,” and that wonder hasn’t diminished today.
That said, dividend growth investing isn’t a set-it-and-forget-it strategy. Success today and beyond depends on:
- Focusing on companies with sustainable business models that can adapt to changing markets
- Being mindful of sectors facing long-term headwinds (like certain fossil fuel companies)
- Considering dividend growth stocks in emerging sectors, not just traditional dividend-payers
- Staying vigilant about companies that might be stretching to maintain their dividend growth streak
Think of dividend growth investing like a well-tended garden. It might not grab headlines like the latest meme stock or crypto coin… but a carefully cultivated one will always be beautiful and bountiful.
Your First Baby Steps with Dividend Growth Investing
Ready to plant your first money tree? Here’s a step-by-step guide to get you started on your dividend growth investing journey:
Step 1: Choose Your Dividend Growth Screening Tool
The foundation of your dividend growth strategy is a reliable stock screener. This tool will help you identify potential dividend growth stars. Here are some of the top options (no affiliate links):
Finviz (Free basic features, $24.96+ per month for premium
Finviz is a versatile stock screener with plenty of filters for dividend investors. The free version is great for beginners, while Elite offers real-time data and backtesting. Its visual charts and heat maps make trend-spotting easy. If you want to mix dividend criteria with other factors, Finviz is an excellent choice.
Dividend.com (Free basic features, $199+ per year for premium)
Dividend.com is all about dividend-paying stocks. Their DARS rating system is a unique tool for evaluating dividend stocks. The free version gives you basic screening, but premium unlocks advanced filters and exclusive research. It’s perfect if dividends are your main focus.
Simply Safe Dividends ($399+ per year)
Simply Safe Dividends is pricey but comprehensive. Its Dividend Safety Score helps you avoid dividend cuts before they happen. You also get detailed reports, portfolio tracking, and stock ideas. For serious dividend investors, the depth of analysis can be worth the cost.
Seeking Alpha (Free basic features, $239+ per year for premium)
Seeking Alpha offers solid tools for dividend investors, including their Dividend Grades. You also get access to a wealth of articles from various contributors. The free version is decent, but premium gives you better filters and exclusive newsletters. It’s great if you like to combine data with diverse market opinions.
Picking the right platform is like choosing a car, so take your time with the decision. The best one depends on where you’re going and how you like to drive. Many offer free test drives of their premium features, so take a few for a spin before you commit.
Step 2: Build Your First Watchlist
Now that you have a screening tool, it’s time to create your first watchlist. This will not be your “final” or “perfect” watchlist, so don’t overthink this step. We’re just trying to get the ball rolling, and you can tweak this list at any time.
a) Run your screen. Consider using some of the metrics and targets that we covered above, in Finding Future Dividend Aristocrats: What to Look For. Aim to add 15-20 stocks to your initial watchlist.
b) For each stock on your list, note down:
- Company name and ticker symbol
- Current dividend yield
- 5-year dividend growth rate
- Payout ratio
- Sector
- Notes of your personal thesis for the stock
c) Diversify your watchlist. Ensure you have stocks from at least 5-7 different sectors.
d) Consider including some existing Dividend Aristocrats or Kings.
e) Set up alerts for significant news or dividend announcements for your watchlist stocks.
Step 3: Tips for Your First Dividend Growth Portfolio
As you build your first dividend growth portfolio, keep these tips in mind:
Start Small with Fractional Shares
Don’t let a hefty price tag scare you away from quality dividend growers. Many brokers now offer fractional shares, letting you buy companies with high share prices using whatever amount you’re comfortable with. For example, if a share of Dividend King XYZ costs $300, but you only have $50 to invest, you can buy 1/6 of a share.
Embrace Dividend Reinvestment Plans (DRIPs)
DRIPs let you put the power of compounding into motion on autopilot. These plans automatically reinvest your dividends to buy more shares of the same stock, often without any additional fees. It’s like your money tree is planting its own seeds. Most brokers offer this feature, so be sure to turn it on for your dividend stocks.
Balance High Yield vs. High Growth Potential
When building your portfolio, you’ll face a choice: chase high current yields or focus on companies with lower yields but higher dividend growth rates. While a 6% yield might look tempting compared to a 2% yield, remember our SteadyCo vs. GrowCo example. There’s usually a tradeoff.
Companies with the highest yields tend to have limited growth potential. Companies with more modest current yields have more “ammo” to grow, as they are reinvesting more of their profits back into its own expansion. A good starting strategy is to aim for a mix of the two.
Conduct Your Due Diligence Before Investing
Before investing, dig deeper into each company on your watchlist. A great starting place is the company’s investor presentation (found on their investor relations site). This will give you a high-level, qualitative understanding of the company. You should also research the company’s competitive position in its industry, as well as any other important industry-specific factors.
A Money Tree Takes Root: Your Dividend Growth Journey Begins
Now that you’ve got the basics of dividend growth investing under your belt, you’re ready to plant your first money tree. But this is just the beginning. As you gain experience, a whole new world of advanced techniques opens up. Here’s a sneak peek at what’s ahead:
- Dividend Growth Forecasting: Learn to predict future dividend increases. Imagine spotting the next Dividend King before it even becomes an Aristocrat.
- Yield on Cost Optimization: Master the art of maximizing your yield on original investment over time. A stock yielding 2% today could be yielding 10% on your initial investment in a decade if you choose wisely.
- Sector Rotation in Dividend Investing: Some sectors shine in different economic conditions. Learn to adjust your dividend portfolio based on the economic cycle to boost your total return.
- International Dividend Growth: Many investors focus solely on U.S. stocks, but there’s a whole world of international dividend growers out there. Learn how to navigate foreign markets and currencies to diversify your income streams globally.
- Integration with Value Investing: Merge in the principles of value investing to find undervalued companies on the verge of major dividend growth.
Remember, the end goal isn’t just to collect dividends, but to understand the business models that generate them. Each dividend payment is a piece of the larger picture of the company as a whole. Your job is to piece them together and, over time, create your own flourishing money tree orchard. So what are you waiting for? Let’s start planting those seeds.