What Is Dividend Growth Investing?

Dividend growth investing (DGI) is one of many common investment strategies in the stock market. DGI is a common form of income investing that focuses on first growing a dividend income stream and allowing the market value to follow. While not ignored, a dividend investor's primary focus is on cash flow rather than the stock's price appreciation.

Why Invest in Dividend-Paying Stocks?

One reason why dividend growth investing is attractive to investors is that it emphasizes total market returns over a long duration, encouraging the "buy and hold" mindset.

While it is possible to generate significant returns trading stocks over shorter time frames to produce income, it is not practical for the typical investor.

Dividend growth stocks, or stocks that regularly increase their dividend payouts, tend to provide strong earnings using relatively low leverage, meaning the company is financially strong and that management is disciplined.

Dividends Preserve Buying Power

One benefit dividend investors often tout for dividend growth investing is that dividends hedge against inflation. The argument is that if a stock appreciates by less than inflation for the year, if the stock pays a solid dividend, the investor comes out on top. For example, a stock's market value appreciates by 4% over the given year while inflation hits 5%, meaning if the company didn't pay a dividend, the investor lost 1%. If that same company paid a 3% dividend yield, the investor's returns have successfully beat out inflation, and the investor has preserved his capital and gained additional purchasing power.

Dividend payments can also help offset a decline in stock price reducing your risk exposure and smoothing the volatility of your portfolio. Because receiving dividends can help stabilize your portfolio during a bear market, it may bring additional peace of mind, making it easier to weather the storm. In addition to this, companies that pay a reliable dividend have often outperformed non-dividend-paying stocks during market downturns. Dividends also provide available cash flow to reinvest during sideways, bear markets, and corrections allowing the investor to accumulate additional shares, boosting their future cash flow.

High Dividend Yield Stocks

Dividend growth investing isn't all about obtaining the highest yield possible. Companies promising high dividend yields should automatically throw up a red flag and get thoroughly vetted to ensure financial stability. These high dividend payers may be using their dividend distributions as a desperate attempt to lure investors into buying fool's gold.

However, a stock's high yield may be temporary. For example, a black swan event may have occurred, causing high levels of fear and skepticism to crash the market. The company may have chosen to reward loyal investors by maintaining its dividend.

As always, performing proper due diligence is necessary when investing hard-earned money into any company, whether it is a dividend growth stock or not.

How Dividend Growth Investing Works

Dividend growth investing is all about the compounding effects of reinvesting profits back into the portfolio over time to generate a reliable source of future cash flow. The general idea is to invest in A) quality companies with B) a sustainable dividend payout ratio at C) a fair valuation, which D) continually increases their dividend. Once you receive those dividends, reinvest them back into the portfolio. That could mean simply purchasing additional shares of the same company, setting up a dividend reinvestment plan (DRIP), or investing in another company entirely. The whole point is to take advantage of the snowball effect of compounding interest to generate a lifetime source of passive income.

Concerns and Disadvantages With Dividend Growth Investing

One common argument is that dividends are not always guaranteed. For any reason, a company could cut its dividend by a substantial amount or even eliminate it, which would be disadvantageous to dividend investors. As we saw in 2020, many companies did this. However, many companies also continued to increase their dividends even during stressful times in the market.

Another common concern is about the taxes one might pay over time. The argument is that investors must pay tax on their received dividends instead of allowing the company to reinvest the cash back into the company, potentially resulting in the stock's price appreciation. However, many dividend investors may counter back by stating they hold their dividend-paying stocks in a tax-exempt account, such as a ROTH IRA and that some companies may not have a better use for the cash

As you can see, there are dozens of considerations to make surrounding dividend growth investing. As with any strategy, it's crucial to research counterarguments and determine for yourself whether you wish to employ them. Dividend growth investing isn't a foolproof strategy. It requires due diligence.

Summary

Dividend growth investing, in short, is focused on building a portfolio consisting of high-quality companies purchased at fair valuations, who pay a dividend and display a historical trend of increasing their dividend payouts. The ultimate goal for dividend investors is to create a passive income stream they can live off. Dividend investors emphasize cash flow for wealth rather than a stock's price appreciation.