Posted on May 20th, 2014

It is better to have a long history of dividend increases over a short one, and more dividend growth over less. Emphasizing dividend growth over current yield also seems to chime with the times. Investors are concerned about the impact of rising interest rates on high-yielding stocks, and it’s plausible that more growth-oriented issues could outperform when the economy eventually moves out of first gear.

Yet all else is rarely equal. A clock-work like pattern of dividend hikes over the past 10 years can help us find and evaluate potentially worthwhile stocks, but far more important is what will happen over the next 10 years. Rapid dividend growth can be a meaningful driver of total returns’ too, but the nature of rapid growth is that it eventually has to slow–and most fast-growing dividends provide below-average yields. As in so many other aspects of investing, we must deal with trade-offs. 

Though I require dividend growth to round out a good total return, I strongly prefer above-average yields even if it means giving up some growth. It’s not just about current income: The total returns strike me as more attractive given the risks.

Dividend Achievers: Past or Future?
The concept of “Dividend Achievers,” companies with at least 10 years of uninterrupted dividend growth, was popularized by a division of Moody’s that is now known as Mergent. Mergent continues to publish quarterly guides in book form. No less an authority than Peter Lynch said, “Buy the stocks on Mergent’s list and stick with them as long as they stay on the list.” Standard & Poor’s later came up with its own “Dividend Aristocrats” list, requiring 25 years for companies in the S&P 500 or 20 years for members of the S&P 1500 (an index that combines the large-cap S&P 500, the mid-cap 400, and the small-cap 600). Lists like these have been used to create several exchange-traded funds, the largest of which is Vanguard Dividend Appreciation (VIG).

Many of these “achievers” and “aristocrats” too deserve here is respect. Still, one essential element of their nature has never escaped my attention: All the stocks that make the list get there on the basis of past performance. Past may be prologue, but it’s far short of a guarantee. Dozens of dividend growth streaks ended in ignominy in 2008 and 2009, including those for the vast majority of financial services firms. Moreover, it’s not necessarily much of an achievement if all that matters to a company is staying on the list. Consolidated Edison (ED) has a 39-year streak of dividend growth going, but in the past 20 years the average annual dividend increase has been just 1.2%–half the rate of inflation. 

Rummaging through the DividendInvestor portfolio archives, I discovered that only about half of the purchases qualified as dividend achievers when first bought. Of those that didn’t have 10-year streaks in place, half of those hadn’t yet been public companies for a full 10 years, which can’t help but rule them out of an achiever approach. But as long as that earnings are going to grow and management will reward shareholders with rising dividends, one doesn’t need to wait for a 10-year record to be established. Achiever status is helpful, but there’s no reason it should be necessary. The hard part is separating the mediocre from the winners.

Requiring a 10-year or longer records of dividend growth before buying, one could not have acquired any of the eight stocks that have turned out to be the best performers. This group has led.

Overall, stocks we bought that were not dividend achievers at the time have outperformed those that have–a conclusion that surprised even me. The achievers have provided an average total return of 18.5% while we’ve owned them, a result that fell 4.6% short of the S&P 500 over comparable holding periods. Meanwhile, the non-achievers (or achievers-to-be, in many cases) provided us with an average total return of 35.0%, beating the S&P by 10.1%.