Although I think of myself as investing in defensive value stocks, I could just as easily call them dividend growth stocks.
That’s because finding companies with a good combination of dividend yield and dividend growth is absolutely central to everything I do.
One thing I’ve learned from putting dividends at the heart of an investment strategy is that dividend investors typically need longer time horizons than investors who focus on capital gains.
Companies usually pay dividends every six months, so a dividend investor who buys into a company will often have to wait several months for their first dividend payment. In the weeks and months between dividend payments and quarterly results, there is very often nothing for the dividend investor to do.
Capital gains, on the other hand, occur almost every second of the trading day (as do capital losses), so there is always something for the investor focused on capital gains to get excited (or depressed) about.
As a result, the investment time horizon of dividend investors should almost always be measured in years rather than days, weeks or months.
This fact should have a profound impact on the way investors select dividend growth stocks.
Personally, I’m quite likely to end up holding a company for anything up to ten years or more, so I am of course very interested in whether a company is likely to sustain and grow its dividend over that sort of time frame.
For me, the best way to build up a picture of what a company might achieve over the next ten years is to look back at what it achieved over the past ten years.
There are quite a few steps involved, but the first few are the most important and I described them in some detail in December’s Master Investor magazine:
How I find long-term dividend growth stocks
- Download the article (PDF)
- Download the magazine (PDF)
- Read the magazine online (ISSUU)
- Visit MasterInvestor.co.uk
For me dividends are a way to drain a company of its resources. If they “have to do it”, at least let them do it in a tax efficient way by shares buy back.
I was looking the other day at one FTSE 250 company which paid dividends over the last 15 years the amount its debt increased over the same period. In the meantime it paid an interest rate on this debts of between 10% per annum to 5.5% per annum, apart from the fees it paid to its investment bankers to issue it.
I did a calculation based on the return on capital reinvested to figure out where the company would have been should instead of making dividend payments and paying interest on borrowing, it would have reinvested the cash in its own business.
I am not against repaying investors when cash builds up and cannot be reinvested elsewhere and there are no debts. I expect Apple Inc to do it once Mr. Trump will only charge 10% corporate tax on overseas earnings and as a result $100 bln could be repatriated.
You may say that it is best that dividends are paid out as you the investor can realocate the capital. That works if the company you hold does not borrow money to invest and alocate capital as well. If that happens you end owing companies that leverage themselves up. However it works even worse if the investor use the dividend to buy more shares in the same company – investors as companies could make poor allocation of capital as well.
Tesco is another example of this poor strategy to pay dividends and leverage up in the same time.
Hi Eugen, I agree with pretty much all of that. My preference for capital allocation within a company goes something like this:
1) Pay down debt if there’s too much of it (however “too much” is defined)
2) Invest in existing business if reasonable rate of return can be achieved
3) Invest in organic growth if reasonable rate of return can be achieved
4) Buy back shares if the price is right
5) Acquire other companies if the price is right and the acquisition won’t be disruptive to the core business
6) Pay dividends
As for Tesco, I think it fell over at the first three hurdles, having too much debt and investing too much in a low return business.