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Wednesday, April 20, 2016

Dividend Aristocrats for Dividend Growth and Total Returns

Investing in dividend growth stocks has been a winning investment over the past 8 – 10 years. I myself have invested in dividend growth stocks for over eight years.

Eight years ago, I told you that I like the list of dividend aristocrats. S&P 500® Dividend Aristocrats measure the performance S&P 500 companies that have increased dividends every year for the last 25 consecutive years. The Index treats each constituent as a distinct investment opportunity without regard to its size by equally weighting each company. The elite group of dividend aristocrats had outperformed the S&P 500 over the preceding 18 years. The special thing about this group of stocks was their track record of annual dividend increases which exceeded a quarter of a century. It made logical sense to me that it is worth studying:


1) A company whose business managed to grow for decades, and

2) Generate the extra cash to reward shareholders with a dividend raise for at least 25 years in a row

In general, I found that most companies manage to grow dividends for 25 years in a row because they have a solid competitive position, or a mini-monopoly in their niche. This allowed them to earn money throughout any economic environment, and reward long-term investors with dividend hikes and strong total returns. This meant that those companies are quality ones.

There are 50 dividend aristocrats today, with an average yield of 2.50%.

TICKER
COMPANY
SECTOR
YEARS*
P/E - ttm
Yield
MMM
3M Co
Industrials
53
22.27
2.64
ABT
Abbott Laboratories
Health Care
43
14.83
2.39
ABBV
AbbVie Inc.
Health Care
43
19.01
3.85
AFL
AFLAC Inc
Financials
33
11.43
2.45
APD
Air Products & Chemicals Inc
Materials
33
23.97
2.37
ADM
Archer-Daniels-Midland Co
Consumer Staples
41
12.52
3.28
T
AT&T Inc
Telecommunication Services
31
16.26
5
ADP
Automatic Data Processing
Information Technology
41
28
2.35
BCR
Bard C.R. Inc
Health Care
45
116.83
0.47
BDX
Becton Dickinson & Co
Health Care
44
49.12
1.67
BF.B
Brown-Forman Corp B
Consumer Staples
31
29.36
1.6
CAH
Cardinal Health Inc
Health Care
28
20.49
1.84
CVX
Chevron Corp
Energy
28
39.69
4.37
CINF
Cincinnati Financial Corp
Financials
33
17.2
2.92
CTAS
Cintas Corp
Industrials
31
16.02
1.16
CLX
Clorox Co
Consumer Staples
39
24.42
2.43
KO
Coca-Cola Co
Consumer Staples
53
27.6
3.05
CL
Colgate-Palmolive Co
Consumer Staples
53
46.88
2.2
ED
Consolidated Edison Inc
Utilities
41
18.73
3.56
DOV
Dover Corp
Industrials
53
12.08
2.54
ECL
Ecolab Inc
Materials
30
34.64
1.21
EMR
Emerson Electric Co
Industrials
53
14.6
3.45
XOM
Exxon Mobil Corp
Energy
33
22.08
3.42
BEN
Franklin Resources Inc
Financials
34
12.66
1.81
GPC
Genuine Parts Co
Consumer Discretionary
53
21.47
2.67
GWW
Grainger W.W. Inc
Industrials
44
20.3
2
HCP
HCP Inc
Financials
29
FFO = 11
6.56
HRL
Hormel Foods Corp
Consumer Staples
47
28.59
1.48
ITW
Illinois Tool Works Inc
Industrials
44
20.44
2.1
JNJ
Johnson & Johnson
Health Care
53
20.11
2.73
KMB
Kimberly-Clark
Consumer Staples
43
49.27
2.71
LEG
Leggett & Platt
Consumer Discretionary
44
21.17
2.63
LOW
Lowe's Cos Inc
Consumer Discretionary
41
28.32
1.46
MKC
McCormick & Co
Consumer Staples
30
30.57
1.81
MCD
McDonald's Corp
Consumer Discretionary
39
26.62
2.79
MHFI
McGraw Hill Financial Inc
Financials
42
23.7
1.44
MDT
Medtronic plc
Health Care
38
44.06
1.96
NUE
Nucor Corp
Materials
42
44.6
3.04
PNR
Pentair PLC
Industrials
39
13.6
2.39
PEP
PepsiCo Inc
Consumer Staples
43
28.27
2.72
PPG
PPG Industries Inc
Materials
44
22.42
1.26
PG
Procter & Gamble
Consumer Staples
53
27.88
3.27
SHW
Sherwin-Williams Co
Materials
36
26.56
1.14
SWK
Stanley Black & Decker
Industrials
48
18.8
2.02
SYY
Sysco Corp
Consumer Staples
35
36.13
2.66
TROW
T Rowe Price Group Inc
Financials
29
16.53
2.82
TGT
Target Corp
Consumer Discretionary
44
15.54
2.74
VFC
VF Corp
Consumer Discretionary
43
22.49
2.32
WBA
Walgreens Boots Alliance Inc
Consumer Staples
40
19.83
1.77
WMT
Wal-Mart Stores
Consumer Staples
39
15.11
2.91

Somehow, against all odds, global financial crises, company failures, and a rise of hatred against dividend growth investing, the dividend aristocrats list has continued doing better than the S&P 500. Who would have thought that a group of solid blue chip stocks with impressive track records could continue breaking records and making their investors wealthier than ever?


As I am writing this, the S&P Dividend Aristocrats index is close to an all-time-high. The S&P 500 is a few percent below its all time highs that were set in June 2015. Investors who purchased dividend growth stocks 8 years ago and stuck with their strategy not only enjoyed dividend income that grew each year but also market beating total returns.

Yet, despite all of this, I keep getting told that dividend growth investors would have been better off indexing. I am going to examine this theory, and use actual data points from the past decade to see if it holds the smell test.

1) The most interesting fact is that the dividend aristocrats had done better than S&P 500. Of course, whether this will hold true over the next decade is anyone’s guess. As we had seen before, a diversified portfolio of stocks would likely have similar returns over time to a so called market index. I didn’t know in 2008 whether it would hold true or not either. Based on the actual data, it seems that investing in dividend growth stocks resulted in better returns than S&P 500. Please refer to the chart above for more information.

2) An even more interesting fact is that most index investors also hold a substantial portion of their net worth in foreign stocks. Many dividend growth investors on the other hand have minimal exposure to foreign based companies, because they didn't want to overdiversify internationally. Foreign stocks have been a drag on returns for index fund investors over the past decade. I used the Vanguard International Stock Market Index (VTIAX) as a representative for international stock exposure. An investment in international stocks over the past 10 years has done much worse than an investment in S&P 500 ( which itself has done worse than the Dividend Aristocrats).

In fact, foreign stocks have not provided much in terms of returns to US investors over the past decade. Over the past 20 years, US investors who bought foreign stocks would have been worse off than sticking to US funds. Actually, investors would have been better off investing in Certificates of Deposit than foreign stocks. As a side note, back in 2007 - 2008, the narrative sold to investors was that the US was going under and that the rest of the world was going to eat its lunch.


3) An even more interesting fact is that most index investors also hold a substantial portion of their net worth in bonds. I used the Vanguard Total Bond Market Index (VBTLX) as a proxy for total bond market. Over the past ten years, bonds have done pretty well actually.


As you can see the claims by some index fund investors that "indexing performs better than anything else at all times" have been proven wrong over the past decade by the actual data. Perhaps a group of mutual funds that cost 2%/year will do worse after fees than a portfolio that cost 0.05%/year in the same narrowly defined group of investments ( such as Large-Cap US stocks). But you cannot say that your portfolio of mutual funds that you picked will do better or worse than the portfolio of someone else.

It is amusing to watch people who claim that they do not poses the experience to pick individual stocks somehow have decided that they have the experience to pick different assets classes such as US stocks, international stocks, bonds, etc. It is even more amusing observing these people make claims that a portfolio consisting of their selections will do better than the portfolios of other investors. Little do they understand that there is absolutely no way to know in advance whether the fund picks they make will do better or worse than the stock selection made by others. As you can see from the charts above, an index portfolio consisting of S&P 500, International Stocks and Bonds did worse when compared to a portfolio that consisted only of US stocks or Dividend Aristocrats.

Anyone who claims that they know that their fund selection or stock selections would be better than the selections of others is either extremely arrogant or extremely ignorant. So to reiterate - there is no guarantee that the selections of index fund you make will do better or worse than the selections of other investors. Plus, there is no guarantee that your index fund selections will even turn in a profit.

As we all know however, past performance is not a guarantee for future results. While I have had a great 8+ years with dividend growth investing, I am not sure what the future holds. Plenty of companies I bought a long time ago have done phenomenally well. However, many of them have also started to disappoint in terms of dividend growth and fundamental performance. For example, Coca-Cola (KO) and Procter & Gamble (PG) have not been able to grow earnings per share for several years. Other companies like Brown-Forman (BF.B) or McCormick (MKC) have grown them, but sell at insane valuations ( though in comparison to some hot but unproven tech companies, a consumer staple selling at 30 times earnings looks like a bargain these days). The environment today is different than the environment of late 2007 and early 2008. In a way, it it similar to the environment from 1999 - 2000. However, it is not impossible to find good companies for further analysis. A review of the dividend aristocrat list which ignored stocks selling at more than 20 times earnings produced 21 stocks for further research. Check this list:

TICKER
COMPANY
SECTOR
YEARS*
P/E - ttm
Yield
ABT
Abbott Laboratories
Health Care
43
14.83
2.39
ABBV
AbbVie Inc.
Health Care
43
19.01
3.85
AFL
AFLAC Inc
Financials
33
11.43
2.45
ADM
Archer-Daniels-Midland Co
Consumer Staples
41
12.52
3.28
T
AT&T Inc
Telecommunication Services
31
16.26
5
CAH
Cardinal Health Inc
Health Care
28
20.49
1.84
CINF
Cincinnati Financial Corp
Financials
33
17.2
2.92
CTAS
Cintas Corp
Industrials
31
16.02
1.16
ED
Consolidated Edison Inc
Utilities
41
18.73
3.56
DOV
Dover Corp
Industrials
53
12.08
2.54
EMR
Emerson Electric Co
Industrials
53
14.6
3.45
BEN
Franklin Resources Inc
Financials
34
12.66
1.81
GWW
Grainger W.W. Inc
Industrials
44
20.3
2
ITW
Illinois Tool Works Inc
Industrials
44
20.44
2.1
JNJ
Johnson & Johnson
Health Care
53
20.11
2.73
PNR
Pentair PLC
Industrials
39
13.6
2.39
SWK
Stanley Black & Decker
Industrials
48
18.8
2.02
TROW
T Rowe Price Group Inc
Financials
29
16.53
2.82
TGT
Target Corp
Consumer Discretionary
44
15.54
2.74
WBA
Walgreens Boots Alliance Inc
Consumer Staples
40
19.83
1.77
WMT
Wal-Mart Stores
Consumer Staples
39
15.11
2.91

I would think that a diversified portfolio of dividend growth stocks should do well over the next decade, as long as the investor is holding patiently and does not panic to sell low. It is more likely however that returns will be more in line with the returns on S&P 500 over the next 8 - 10 years.

Of course, as I have mentioned before, all I care about is that the amount of dividend income I earn pays for my expenses and grows at or above the rate of inflation. I would gladly underperform any benchmark you mention, as long as I hit my dividend income goals and live off dividends for the next 30 – 40 years.

On the other hand at this stage, the contrarian in me wants to state that perhaps international stocks could be a better value over the next decade. They have better yields and lower P/E ratios than US stocks today. If the US dollar depreciates against other developed currencies, this should produce some tailwinds to profits of international stocks. This should be good news to US multinationals as well however. And this could be an opportunity for me to focus on the list of international dividend achievers.

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