Dividend Growth Investing:

Why It's Superior to Growth Investing

We're not all wired the same way, after all. As a result, we can't all recognize, appreciate, and capitalize on the same opportunities.

With that being said, allow me to present the following case in favor of Dividend Growth Investing that demonstrates—in my mind, at least—its superiority over regular Growth Investing.

The Allure of Growth Stocks

But the dirty secret of all long term secular bull markets is that most of the returns are the result of an expanding Price-to-Earnings ratio, not simply due to increasing corporate earnings. Yes, earnings increased throughout the 1982-2000 period, but in 1982 investors only had to pay $8 for each dollar of those earnings. By the end of the party, however, they were paying $30 for each dollar in earnings.

[Those are the average for the whole market - at the height of the internet bubble, crazed market participants (somehow it doesn't seem right to call them "investors") had bid up the P/E on individual tech stocks to astronomical levels.]

The average annual real return during the 1982-2000 period was 14.8% (source: Micheal A. Alexander, Secular Market Trends).

Who wouldn’t take that? An investment that compounds at an average of nearly 15% annually for 18 years is going to create some serious wealth.

The Incredible Shrinking Returns

Compare that 14.8% average return with what preceeded it during the 1966-1982 period: an average annual return of -1.5%. That’s right – a 16 year period with a negative average annual return.

And what happened following the secular bull market of 1982-2000? Consider the table below that shows the 10 year returns on the three major market indices from the end of year (EOY) 1999 through the EOY 2009:

The Performance of Dividend Growth Investing

Let’s further imagine that you held these stocks through the duration of the bull market. What would your effective yield, or yield on cost, be (the current annual dividends divided by your original investment)?

And, just as importantly, what would your effective yield be at the end of 2009, as a buy and hold investor who survived this bleak first decade of the 21st century?

The results on both counts, I find, are staggering:

Will every dividend paying company produce these kind of results? Of course not. Just as not every growth company turns out to be Microsoft in the 1990s. But the great advantage that dividend growth investing in superior companies has over growth investing is that your yield, and therefore your income, increases in bull markets and bear markets alike.

When you invest in superior, dividend paying companies, it's much more realistic to expect a positive dividend growth rate than a market cap (i.e. the current valuation of that company) that just keeps going up and up.

Dividend growth investing doesn’t take a decade (or longer) off before making you money. The formula, in fact, is the essence of simplicity: high quality, dividend paying companies + time.

That’s all there is to investing success and long term wealth.

[You literally need nothing else, but for the savvy, creative types who want to learn how to shave years off the process, there’s always Leveraged Investing.]