I tend to focus my attention on companies that regularly increase dividends to shareholders.
A long history of annual dividend increases is often the result of a strong business, with strong competitive advantages, with high return on investment, which tends to gush rising tides of free cash flows.
It's a symptom of a strong business.
However, that doesn't mean that every dividend increase is treated the same or that you should not look under the hood to understand the drivers behind that dividend increase.
I view dividend increases as signals, that indicate management's stance on the company, industry and economy. They simply are one aspect of my process.
A history of dividend increases will put a company on my map for sure. However, I do additional work from there to determine if a company is worth researching and even potentially adding to my portfolio.
That works includes reviewing trends in:
- Earnings Per Share or FCF/share
- Dividend Payout Ratios
- Growth in dividends per share
- Shares outstanding
- etc
I also try to put dividend growth in context.
A company that just initiated dividends would likely grow those dividends faster than earnings, especially as the dividend payout ratio is starting off on a low point.
But a company that grows dividends faster than earnings and is not in the initial phase of dividend growth can only afford to do so through an increase in the dividend payout ratio. That has a natural limit to it.
A company that grows earnings and dividends at roughly similar rates is typically what you end up seeing. That being said, there could be some volatility in dividend growth rates from year to year, and also volatility in dividend payout ratios over periods of time.
In addition, I like to discuss the trade-offs between dividend yield and dividend growth in this context.
Namely there are three types of dividend growth stocks:
1. High Dividend Yields but low dividend growth
2. Those in the Sweet Spot in terms of generating medium dividend yield and medium dividend growth
3. Low Dividend Yield but High Dividend Growth
Naturally, there are trade-offs between higher yields and lower yields, and higher expected growth versus lower expected growth. You also need to take into consideration the payout ratio, the maturity of the industry you are in, the type of business entity you are evaluating as well.
Nothing is a one size fits all approach.
I am mostly saying all of this because I see incorrect statements on the internet, presented as facts (I know, big surprise) that dividend investors are easily fooled by any dividend announcement or dividend increase or dividend streak. I've been doing this for close to 2 decades now, and I have not really seen this happen. Perhaps some novice investors do fall for this trap once or twice, but they learn from it.
Dividend investors usually look under the hood when investing in a company, meaning they review fundamentals to determine dividend safety and potential for dividend growth, and try to acquire stocks at a good valuation.
This perspective of looking under the hood before you buy is also evident in dividend investors who buy ETF's too. They also look under the hood as well, in order to determine what they are getting themselves into.
It is important to look under the hood, and try to evaluate the data using some simple logic. It's also important to avoid making a conclusion, without really looking at all the facts.
Now I am sure there are some that just keep buying without doing any work, but from my experience, those would be a minority.
