Today, I am writing my Thoughts On Money from 30,000 feet in the air as I head to Denver, where we will be hosting a client dinner this evening. Last week, I was in Dallas on a similar trip. It’s always a joy to connect with our clients from around the country and to visit our other TBG offices.
The inspiration for today’s article was indeed a question I got from a client/friend in Dallas. He asked, “I’ve read all the content, experienced it firsthand, and I’m a believer in dividend growth, but why doesn’t everyone invest this way?”
Yesterday I joined a meeting with a potential client, and I like how he framed his question: “I know everyone says their approach is the best since sliced bread, but why should I consider dividend growth?”
Two unique and distinct questions, both born from the same soil, “Why dividend growth?” There are a lot of different ways to approach this question, and today I will provide my shorthand answer for why I personally invest this way.
So, place your seats in the upright position, buckle up, and prepare for takeoff…
Built to Last
My friend in Dallas wanted to know why he doesn’t see more advisors taking a Dividend Growth approach, and I thought this would be a nice place to start our discussion. Sure, I don’t know every advisor in the country, but I know quite a few, and he’s right that there just aren’t a lot of dividend evangelists out there.
So, the question is, why? In reality, most advisors simply don’t have a consistent and long-held investment philosophy. Many advisors outsource the investment management and promote the wisdom of some outsider – this or that portfolio manager. Then, when things get uncomfortable or the advisor feels disappointed with said manager, they pivot and hire some other “five-star” manager.
Having a philosophy and being public-facing with your approach is a difficult endeavor. So much of investor success depends on endurance and fighting through the discomfort. The feeling of inconsistency (in results) is why so many have trouble staying consistent with an investment strategy. The majority are most likely to adopt a rearview mirror investing approach in which they seek to mimic what has done well recently.
I can’t tell you how many times Warren Buffett has made the front page of some business journal with the headline “Is Value Investing Dead?” Yet, one of Mr. Buffett’s greatest qualities is having very little interest in the opinions of pundits and others. No amount of social pressure has pushed Buffett away from his approach to investing, and it’s that very endurance and commitment to conviction that has powered his resilient results.
2020 was a difficult year to be a Dividend Growth investor. I mean, let’s be honest, 2020 was a difficult year in general. The stock market plummeted by some +30% in the spring and then quickly rebounded to an above-average return by year-end. Yet, most dividend growth investors were flat to negative this year. One reaction could be to get disgruntled with the relative underperformance and abandon the strategy. Another reaction would be to understand that the market was being driven by a “work-from-home” or “everything-from-home” speculation bubble that was driving prices up temporarily.
For me, history makes it very clear that dividend growth is a built-to-last strategy; a strategy that has weathered many of the market storms of years past. I know not every day, week, month, or even year will be comfortable, but I’m reminded that my “stick-to-itiveness” is what will yield the rewards (results) in the end.
Responsibility & Accountability
In the last decade my life has changed quite a bit. Of course, the joys of being a father and husband are the highlight of that change, but the sheer responsibility that I have today versus then is incomparable.
There was a time when I could leave for a trip on a whim or make some large financial decision without considering anyone else. Now, I’m accountable to other people, and I must act responsibly.
Think about what a dividend actually is. A company sells widgets, uses the revenue to cover their expenses, and then they have leftovers (profits) that they must decide what to do with. A company that pays a dividend is electing to share those leftovers in the form of a payment to the owners (shareholders). Now, imagine a company that has paid a growing dividend for 50 years, would you agree that this board and that CEO may have an elevated responsibility/accountability to their fellow owners to keep those payments (dividends) consistent and uninterrupted? This has a very similar feel to the responsibility I have today versus that in my younger years. That CEO has some appropriate social pressure not to make a foolish acquisition or take on an irresponsible amount of debt because they know they are committed to that dividend and their shareholders. My mortgage and my kids have a similar impact on my decisions.
The responsibility and accountability associated with dividend growth are qualities of this approach that I find quite attractive.
For What It’s Worth
I’ve used this analogy quite a few times, but I want you to imagine your favorite candy. For me, it’s probably Red Vines (licorice). Now, imagine I walk into a grocery store and see a tub of those delicious Red Vines, but as I approach the shelf, I notice the price is $1,000. This price tag won’t impact my love for licorice, but it will impact my buying decision. Why? Because I know the price of Red Vines well, and I’m not willing to pay that price.
Stocks are not so dissimilar. There are a lot of great companies out there with unattractive stock prices. Valuations matter. Dividend Growth investing has a built-in valuation mechanism that becomes quite helpful. Stocks are not as easy to value as Red Vines, so you need to anchor a stock’s price to another relative metric – earnings, revenue, cash flow, and even dividend income. Then you can compare that ratio to history, sector, and future expectations to land on some measurement of value.
Many years ago, Jim O’Shaughnessy wrote a bestseller called What Works on Wall Street. Jim was an early adopter (or pioneer) of quantitative investing and wrote about some rules-based strategies based on his research. One of his early research projects was on the “Dogs of the Dow,” a strategy that filtered the Dow Jones Industrial Average by its highest-yielding constituents. Essentially, high yielding meant the price (denominator) was lower than normal and/or the income (numerator) was higher than normal. Said in layman’s terms, the stock price was beaten up a bit, but the dividend was undisturbed; a roundabout way of finding Red Vines on sale.
I have much to critique about the Dogs of the Dow, but the concept here is worth noting – a dividend strategy has a built-in mechanism for avoiding speculative high-priced stocks. Not the only advocacy for the strategy, but a nice feature nonetheless.
A Financial Planner’s Dream
Sometimes we need the reminder that the goal of investing is to set aside monies today to grow and to be spent later. The saving part of the plan is a much easier equation than the spending part of the plan. There is an entire industry (financial planning) dedicated to helping people solve this spending equation.
One of the greatest concerns for a financial planner is that the market would deliver a sequence of negative years (e.g., the early 2000s) and an investor would be forced to sell investments at depressed prices to meet their current distribution needs. We call this sequence of returns risk. The industry often uses something called a Monte Carlo Simulation to measure the risk of investors outliving their nest egg. This reality, and the planning behind it, causes many investors anxiety.
Believe it or not, Dividend Growth offers a great solution here. A basic study of market history would show that stock prices are highly volatile, but dividend payments are not. Why does this matter? Because if your financial plan depends on price stability, then you’ll need to run a Monte Carlo and hope for the best; if your dividends can satiate your withdrawal needs, then this sequence of returns risk becomes a non-issue.
Shifting Your Focus
This price volatility I mentioned above is perhaps the investor’s greatest enemy. Price volatility leads to anxiety, and anxiety leads to bad decisions. Bad investor behavior is the primary cause of most financial damage.
So, how can Dividend Growth ease this anxiety? The name of the strategy says it all; the focus is on dividends, a figure much less subject to volatility than stock prices. It takes some getting used to, and it doesn’t happen overnight, but eventually, Dividend Growth helps investors shift their focus from price to income. They realize that income is what they live on, and then all of a sudden, they become much more enamored with the announcement of a dividend increase than with simply a good day in the markets.
This shift in focus is one of the most freeing feelings for an investor. Sure, CNBC and Fox Business will continue to focus on the day-to-day gyrations, but you don’t have to. What was once a fear-inducing headline can now make you chuckle as you either celebrate dividends reinvesting at lower prices or just knowing that your income is secure.
The Why for Me
As I mentioned earlier, today’s discussion was a recap of why I resource and advocate for this approach personally. My reasoning here was not exhaustive, but it does provide a good recap for why I became convinced that Dividend Growth was appropriate for myself and my clients. What was described above highlighted the benefits of a built-to-last strategy, one that challenges company leadership to be both responsible and accountable, leads an investor to fair or even bargain prices, and provides comfort to both planners and investors who depend on cash flow.
Many people will get to this point in the article and ask, “What’s the catch?” The real catch here is that some other new, exciting, and intriguing strategy will probably catch your attention. That strategy may work for a while, and then it’ll probably disappoint, which will put you back in the market for something else new and eye-catching. I’m not sure how many spectators or speculators were at that famous race between the Tortoise and the Hare, but I’d assume the wagers were leaning heavily in favor of the Hare. The population of dividend growth advocates may be the minority, but I promise you that we are content and feel like we are participating in one of the best-kept secrets.
I am literally landing as I write this, so I will also land our discussion here. For current dividend growth investors, I hope this article provided some good reinforcement. For those employing other strategies and approaches, I hope today’s discussion was thought-provoking.
As always, any and all questions/comments are welcome – please do reach out.
