The Truth About Dividend Investing

Wall Street wants us to believe investing is complicated. Hence, we need to pay advisors to navigate the difficult markets.

Hogwash. Particularly when it comes to dividend investing.

In a previous column, I set out to prove it, too, by providing a seven-step system to finding the market’s safest, highest-yielding stocks.

For some, though, that was six steps too many.

[ad#Google Adsense 336×280-IA]So today, I’m going to distill dividend investing to the single, most important truth.

It’s the bedrock upon which we all should build our income portfolio.

Above All Else, Go With Dividend Growers

In today’s zero-interest rate world, where money market funds and U.S. Treasuries pay squat, investors are clamoring for income.

But they’re being yield hogs.

By that I mean they’re chasing after the highest yields. The problem with such an approach is two-fold…

First, high yields are typically a function of share price declines, not sound fundamentals.

Take Pitney Bowes (NYSE: PBI) and R.R. Donnelly & Sons (Nasdaq: RRD), for instance. They rank as two of the highest-yielding stocks in the S&P 500. Not because of massive dividend increases, but because of massive share price declines of 36% and 45% over the last 18 months.

Second, high yields today don’t guarantee high yields tomorrow. If the actual payout isn’t increasing year after year, once interest rates rise, those high-yield stocks won’t seem so high yield anymore.

That brings us to the most important truth. Namely, instead of chasing yield, we should be chasing growth.

Ultimately, dividend growers return the most. And here’s the data to back me up, courtesy of PIMCO’s Brad Kinkelaar…

Kinkelaar measured the excess performance of dividend-paying stocks versus the MSCI AC World Index. And he found that high-yield stocks outperformed the Index by about 80% since 1988.

That’s nothing to complain about. Until we realize that high-yield stocks with high dividend growth rates outperformed by a staggering 225%.

Another study by mutual fund powerhouse, T. Rowe Price, yielded similar results.

It found that $100 invested in the Russell 1000 Index at the end of 1978 would be worth $4,055 today. That same $100 invested in just the dividend payers in the Index would be worth $4,573 today. And invested in only the dividend growers, it would be worth $5,244 today.

Last but not least is proof that the excess returns delivered by dividend growers aren’t the result of taking additional risk. It turns out dividend growers actually return more on average per year, while taking less risk, according to Ned Davis Research.

Note from DTA: Please disregard the "Lower Risk" and "Higher Risk" labels on the y-axis of this chart.

Add it all up and now you know why we put such an emphasis on dividend growth companies here at D&I Daily. That, and the dividend payout ratio (DPR), which measures a company’s ability to afford more dividend increases.

It’s the easiest way to identify investments likely to generate a modest income today, a growing income stream over time and the most long-term capital appreciation. And who doesn’t want that?

Safe investing,

Louis Basenese

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Source: Dividends and Income Daily