Dividend growth investing is one of the best ways to reach early retirement. There are lots of ways to retire early, but investors should pay particularly close attention to dividend growth, because of the potential for huge returns.
At Business Minded we believe the Dividend Aristocrats are a great place to look for dividend growth stocks to buy and hold for the long term, and by long term, I mean years not months. The Dividend Aristocrats are 57 of the top companies in the S&P 500 Index that have raised their dividends each year for at least 25 consecutive years.
It’s not easy to uphold such a long history of steady growth and dividend increases. In order to make it onto the list of Dividend Aristocrats, a company must have long-lasting competitive advantages, a consistently profitable business model, and shareholder friendly management. Possessing all of these qualities proves that the Dividend Aristocrats are among the highest quality growth stocks.
Why choose from the Dividend Aristocrats
As we mentioned before the Dividend Aristocrats represent the stocks in the S&P 500 Index. The list is recalculated annually by Standard & Poor’s, which also maintains the S&P 500 Index. There were four new Dividend Aristocrats declared in January 2019:
- Chubb Limited
- United Technologies
- People’s United Financial
The composition of the 57 Dividend Aristocrats by sector is as follows:
- 13 Consumer staples and industries
- 7 Financials
- 6 Each from health care
- 2 Energy
- 1 apiece from the technology, real estate, telecom, utilities, and consumer discretionary sectors
To maintain such a long history of dividend growth each year, a company must possess a number of positive qualities.
The Dividend Aristocrats have competitive advantages and sustained growth, which has allowed them to raise their dividends for at least 25 years. In more than one case, Dividend Aristocrats have raised their dividends much longer than 25 years, 3M Company which is in the industrial conglomerates industry are the longest running Dividend Aristocrat, holding strong for 61 years as of April 2019. This means these companies have sustained many challenges, including multiple market crashes.
The Aristocrats have proved their worth by outperforming the broader market, with less volatility at the same time. According to the S&P 500 Index generated annualized total returns the market had returns of 12.7% over the last 10 years. In the same 10 years, the Dividend Aristocrats produced annualized returns of 13.7%. 1% may not seem like much, but if you have $1 million dollars in the market, that makes it an extra $10,000 in your pocket.
Also, consider that the last 10 years included an uninterrupted bull market when stable dividend stocks might be expected to under perform the broader index. But just the opposite occurred in the past decade, the Dividend Aristocrats exhibited less volatility than the S&P 500. In the past 10 years, the S&P 500 Index had a standard deviation (a widely-used measure of stock market risk) of 12.4%. This compares to standard deviation of 11.2% for the Dividend Aristocrats in the same 10-year period.
Therefore, the Dividend Aristocrats not only generated stronger total returns than the S&P 500 in the past decade but also had less volatility in that time. We believe the Dividend Aristocrats remain attractive today, even after a prolonged period of over performance. Not only do they offer the potential for higher total returns, they are particularly appealing for income investors. Those hoping to reach early retirement should give preference to dividend growth stocks, because of their ability to provide sufficient retirement income.
Retire early with dividend growth stocks
Investors hoping to retire early have a number of uncertainties to deal with, maybe the most important of which is how to substitute lost income. Those choosing to retire early may have a significant income shortfall. Therefore, investors need to find a way to fill the gap in their income, and that is where dividend growth investing comes in.
The potential for income growth over time is a major reason to invest in the Dividend Aristocrats. Bonds provide fixed income, but dividend growth stocks increase their shareholders’ income by raising their payouts each year. Dividend increases allow shareholders to build income at rates that often exceed inflation, while fixed interest payments from bonds are not protected against inflation. This is how you fill the gaps in lost income.
The distinction may seem insignificant, but it can make a huge difference over time. For example, assume an investor purchases $10,000 worth of 10-year U.S. Treasury Bonds, which currently yields 2.4%. The investor will receive $240 per year in interest income, with no growth from year to year. In year 10, the bond will pay the same $240 that it did in the first year. But suppose that investor instead puts that $10,000 into a dividend growth stock with the same starting yield of 2.4%, but the company increases its dividend at 10% per year. In year 10, the dividend growth stock will pay out dividends of $622, more than double the original interest payment.
In the 10th year, the investor will be receiving a yield on cost of nearly 6.3%. Yield on cost is a valuable calculation for investors to understand, as it shows the effect of dividend growth investing. The yield on cost represents the current level of income received from a stock, based on the investor’s specific cost basis.
There are loads real-life examples that also demonstrate the value of investing in high-quality dividend growth stocks. One prime example is health care giant Johnson & Johnson (JNJ), which has increased its dividend for over 50 years in a row. Today, the company currently pays a quarterly dividend of $0.95 per share, or $3.80 per share on an annualized basis. But 10 years ago, Johnson & Johnson’s quarterly dividend was $0.49 per share. The company has therefore raised its dividend by approximately 6.8% per year over the past 10 years.
Today, Johnson & Johnson stock yields 2.8%. If an investor buys the stock at this level, and the company maintains a dividend growth rate of 6.8% per year over the next decade, in 10 years the investor will have a yield on cost above 5%. With continued investment in dividend growth stocks, investors can gradually build their income to eventually replace their pre-retirement salary.
While there are many ways to reach your goal of early retirement, dividend growth investing is one of the most effective. Dividend growth stocks pay their investors rising amounts of income every year just for owning them, once you have a company you trust it is completely passive. Also keep in mind, the highest quality dividend growth stocks, such as those on the list of Dividend Aristocrats, can maintain their steady dividend increases even during recessions and bearish markets.
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You need to build your knowledge about investing before you dive in, check out our other articles to learn more about the stock market:
- 7 must read books for investors
- Understanding the stock market: A beginners guide
- Every stock market term you will ever need to know