What Is Dividend Growth Investing

Dividend Growth Investing (DGI) is a stock equity investment strategy that combines elements of growth, value and income investing. The basic concept of DGI is to buy shares of dividend paying stocks that have a history of increasing their dividend payout year after year.

When combined with re-investment of paid dividends (or compounding) the strategy becomes a powerful wealth building tool. To better illustrate the benefits here is a comparison of investments using compounding via a bank CD and dividend growth investing:

An investor took $1,000 and deposited it in a 5 year Bank CD paying 4% and rolled the CD over for 30 years (including interest). At the end of 30 years they will be earning $125 annually in interest, a very nice return and display of the power of compounding.

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But, when compared to an investor using the same initial $1,000 investing in dividend growth stocks that pay a 3% yield and increase the dividend payout 10% annually the difference becomes dramatic with a whopping annual payout of $1038 after 30 years.

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The examples above are fixed scenarios and may not reflect actual market returns but were used to demonstrate the difference in compounding versus compounding with dividend growth.

Since DGI is investing in stocks it does carry inherent risks from market volatility and DGI has three analytical aspects to reduce risks:

  1. Historical Dividend Increase History
  2. Ability to continue paying dividend
  3. Ability to continue increasing dividends

A list of companies with historical dividend increases are fairly easy to locate on the web today and most are categorized as follows:

  • Dividend Aristocrats - Increasing dividends for more than 25 years
  • Dividend Champions - Increasing dividends 10 to 24 years
  • Dividend Challengers - Increasing dividends 5 to 9 years

Though historical dividend growth performance cannot predict future performance it is used as a measure of risk.

The analysis of a company’s ability to pay and continually increase a dividend payout requires a basic understanding and use of financial ratios. Some popular analytical ratios used are:

  • Payout Ratio – The amount of dividends paid as a percentage of annual earnings
  • Price to Earnings Ratio Trailing 12 months - A ratio of stock price divided by previous 12 months annual earnings
  • Price to Earnings Forward - A ratio of stock price divided by forecasted next year annual earnings
  • Current Ratio - A liquidity ratio that measures a company's ability to pay short-term obligations.
  • Debt to Equity Ratio – The percentage of debt in relation to a company’s assets
  • Free Cash Flow - A measure of financial performance calculated as operating cash flow minus capital expenditures.
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