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GUEST BLOG POST: The Case for Dividend Investing (Bob Ciura, 2019)

By Bob Ciura, Senior Vice President at Sure Dividend, LLC

There are many different ways to invest. Investors can build their portfolios to include equities, fixed income, derivatives, real estate, commodities, and more. Capital allocation strategies are often based on an investor’s individual needs and risk tolerance. For example, investors who desire income from their portfolio investments should consider dividend stocks.

Investors can simplify the process by investing in an equity mutual fund or exchange-traded funds. For investors interested in buying individual stocks, high levels of income are attainable—along with regular dividend growth—from high-quality dividend stocks.

At Sure Dividend, we focus on the Dividend Aristocrats, which we believe to be among the highest-quality dividend growth stocks around. The Dividend Aristocrats are an exclusive group of companies in the S&P 500 Index that over time, have proved the benefits of dividend investing.
 

Warren Buffett dividend investing

Two Different Types Of Dividend Stocks

Publicly-traded companies can choose whether to pay a dividend to shareholders. Not all companies pay dividends to shareholders. For example, small companies or startups, which are at an earlier stage of their development, may decide it is better to reinvest all cash flows back into the growth of the business.

In order for a company to decide to pay a dividend, it must generate sufficient profits to make the dividend payments to shareholders. Still, not all profitable companies pay dividends. There are many examples of large, profitable businesses that do not pay dividends. Berkshire Hathaway, Alphabet, and Facebook are just a few.

There is also a great deal of variety among companies that do pay dividends. Some companies choose to pay out a relatively large portion of their profits to shareholders through a dividend. Typically, companies in slow-growth industries will maintain higher dividend payouts, as the future growth opportunities may be limited. Utilities and tobacco stocks are examples of high dividend stocks.

Or, companies can distribute less of their profits to investors with lower dividend yields, retaining the ability to grow their dividend payouts at a higher rate down the road. High-growth dividend stocks might be slightly less appealing in the short-run, due to their lower dividend yields, but can compensate investors for this with high dividend growth rates each year moving forward.

Why The Dividend Aristocrats?

We believe the Dividend Aristocrats are an appealing mix of current yield, and dividend growth. For example, the Dividend Aristocrats as a whole have a current dividend yield of 2.5%. By comparison, the broader S&P 500 Index has an average dividend yield of 1.8% right now. Therefore, the Dividend Aristocrats offer a significantly higher level of dividend income than the broader stock market index.

The Dividend Aristocrats represent an exclusive group of 57 companies in the S&P 500 Index that have increased their dividends for at least 25 consecutive years. Some members of the Dividend Aristocrats have managed to raise their dividend payouts to shareholders for 50 years in a row, or even longer in a few cases. Stocks that have increased their dividends for at least 50 years are known as Dividend Kings.

As you might imagine, it is not easy for a company to become a Dividend Aristocrat. The last 25 years included multiple periods of economic recession and geopolitical conflict. To maintain such a long history of steady dividend increases regardless of the economic conditions is a highly impressive accomplishment. It demonstrates a company has a strong brand, leadership position in its industry with growth potential, and durable competitive advantages.

Of the 505 stocks that comprise the S&P 500 Index, just 57 currently qualify as Dividend Aristocrats. Put differently, just over 10% of the S&P 500 Index have made it onto the list, which shows the difficulty of holding such a long history of consistent dividend increases.

The Dividend Aristocrats are also particularly appealing because they have generated meaningful outperformance over time, relative to the broader market index. For example, according to Standard & Poor’s, the Dividend Aristocrats generated total annual returns of 13.8% over the past 10 years. In the same period, the S&P 500 Index generated total returns of 12.7% per year. As a result, the Dividend Aristocrats have beaten the broader market by more than a full percentage point per year, a significant outperformance.

And, the Dividend Aristocrats have exhibited less volatility than the broader market. Consider that in the last 10 years, the Dividend Aristocrats had annual standard deviation (a popular measure of portfolio risk) of 11.2% per year. By contrast, the S&P 500 Index had annual standard deviation of 12.4% per year in the same period. This means not only did the Dividend Aristocrats generate stronger returns than the S&P 500, they also had lower volatility from year to year.

Dividend Investing: Funds or Individual Stocks?

Investors can invest in a basket of high-quality dividend growth stocks, such as the Dividend Aristocrats, through funds or by purchasing individual stocks. The major exchange-traded fund that invests in the Dividend Aristocrats is the ProShares Dividend Aristocrats ETF, under the symbol NOBL. The advantage of purchasing an ETF is that it provides instant diversification. An ETF has a basket of holdings in the portfolio. NOBL has all 57 Dividend Aristocrats among its holdings.

Or, investors can simply purchase individual stocks. The appeal of selectively choosing among the Dividend Aristocrats is that it could provide higher levels of dividend income. For example, while the Dividend Aristocrats ETF (NOBL) has a dividend yield of 2% right now, many of the Dividend Aristocrats offer significantly higher dividend yields. A few examples are AT&T, AbbVie, and Exxon Mobil, all three of which qualify as Dividend Aristocrats and yield more than 5%.

An additional benefit of investing in the individual constituents of the Dividend Aristocrats is that ETFs carry annual fees. To that end, the NOBL ETF has an annual expense ratio of 0.35%, effectively reducing its dividend yield to approximately 1.65%. However, investors should note that investing in individual stocks carries company risk, meaning investors need to monitor the company’s financial results more closely. Investors buying individual stocks should still diversify their portfolio holdings to help reduce volatility.

No matter how an investor chooses to invest in dividend stocks, whether it be through an ETF or by buying individual securities, the Dividend Aristocrats should be a focus for long-term dividend growth.

Final Thoughts

There are many investing strategies to choose from. Investors looking for stable income and high yields, such as retirees, should consider allocating a portion of their investment portfolios to dividend stocks. Investors can choose to invest in a basket of dividend stocks through a mutual fund or ETF. Alternatively, investors can buy individual stocks that pay dividends.

The main advantages of buying individual stocks are that shareholders have voting rights, and can avoid paying annual fees of a mutual fund or ETF. Another major benefit is that many individual dividend stocks pay higher dividend yields than related ETFs.

For income investors willing to accept the various risks of buying individual stocks, the Dividend Aristocrats are an excellent source of high-quality dividend growth stocks to buy and hold for the long-term.

The views and opinions expressed here are those of the author and may not represent the views of Savvy Investor.

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