If you keep your emotions in check, you may find yourself holding companies for decades to come, while enjoying rising dividend income. This passive approach keeps investment costs low, which means that you get to keep your fair share of investment returns. It is easier to practice dividend investing through the difficult times, because you are getting paid to hold the worlds best quality companies.
With dividend growth investing, all we do is buy future income streams. With every $1,000 that I invest, I end up generating $30 - $40 in annual dividend income. This income can be used to pay for my expenses in retirement. If I earned $20/hour, I am essentially buying back 1.5 - 2 hours of freedom with every $1,000 invested. The goal is after several years of saving and investing, to replace your paycheck with the dividend income from your portfolio.
For example, if you invest $1,000 in Altria (MO) today, you will earn an annual dividend of $37/year. This sounds like a small amount of money that many will laugh at you for. But you should not despise the days of small beginnings. As the company earns more, it will pay more dividends. If earnings per share double over the next decade, and dividends follow along, your stake will be earning $74/year ( without factoring in dividend reinvestment). As you save more money, you can buy more shares in other companies. Perhaps you will add $1,000 in Tanger Factory Outlets (SKT), which will add $52 to your annual dividend income. You may also keep adding stakes in more promising dividend growth companies at attractive valuations that you stumble upon on your journey. They will generate more dividend income for you over time.
Your job is to keep stacking those income streams from there. Keep saving that money, and buying one income stream on top of the next. Then use those dividends during the accumulation phase to reinvest back into more income streams. Compound that income over time, and the results would be surprising for you.
In order to find good quality dividend growth stocks, we always start with the list of Dividend Champions, Contenders and Challengers. When evaluating companies:
- We want a long track record of dividend growth
- We want growth in earnings per share
- We want an adequate dividend payout ratio
- We want a good rate of annual dividend growth
- We want to buy that future income stream at an attractive valuation
- We want to patiently hold on to our securities for years
- We want to keep investment costs as low as possible
- We want to have diversified portfolios that can withstand anything
All of this encourages long-term thinking. You can ignore stock market fluctuations, news pundits, market forecasters etc. Your job is to find enough of those companies that have a track record of annual dividend growth, to purchase them at an attractive valuation, and to then hold on to them for decades.
For example, a decade ago Johnson & Johnson (JNJ) sold at $60/share, which was roughly 16 times earnings. The company paid a dividend of 41.50 cents/share every quarter for an yield of 2.80%. This was a well known company, that everyone knew about. In fact, it was one of the first companies I analyzed when I started this site in early 2008. The investor who focused on earnings, dividends, and ignored stock fluctuations enjoyed a solid rise in dividend income over time. Their $1,000 investment produces $56 in annual dividend income today ( assuming no dividends were reinvested). With dividend reinvestment, our shareholder would be earning a cool $78 in annual dividend income, and would be close to tripling their initial investment. This is how business owners think, and act.
Johnson & Johnson has managed to reward shareholders by growing the annual dividend from $0.43/share in 1997 to an estimated $3.32/share in 2017.
We realize that capital gains come and go. Investors usually focus mostly on capital appreciation after a long bull market. When stock prices rise relentlessly, it seems silly to want dividends.
I do not like approaches to retirement where I will be relying exclusively on capital gains. Those capital gains are more difficult to rely on when you need them. With dividend growth investing, I get dividend payments and capital gains as well. I find my approach to be safer, because I have diversity in my sources of investment return. Based on the data, it is obvious that dividend income is more reliable than capital gains. If this ever changes, only then will my approach change.
Since we are prudent investors who are interested in living off our nest eggs through thick or thin, we like the all weather approach that dividends provide. Dividends are more stable, and reliable source of returns than capital gains. Dividends are easier to forecast than share prices. This is why they are the perfect source of income for retirement. This is why I have chosen to model my retirement exclusively on dividends.
Full Disclosure: Long JNJ, MO, SKT
Relevant Articles:
- Financial Independence Is Easier to Model with Dividends
- Dividend Investors Should Ignore Market Fluctuations
- How to think like a long term dividend investor
- The advantages of being a long-term dividend investor
- Dividend income is more stable than capital gains