Why I like growing dividends

Dividend growth investors typically focus on companies with stable operations, low debt, economies of scale, and that manufacture or sell everyday goods and services. My portfolio is filled with high-quality companies with competitive advantages, brands, technological advantages or patents. This strategy has more than one advantage for investors who have a long-term horizon and who have set financial independence as their main objective.

Here's why I particularly like growing dividends:

1. Investors who buy an asset with the hope of reselling it later at a profit may be particularly affected by volatility of the market. This is one of the many reasons I have stayed away from gold. Emotions are the cause of wealth destruction. If you buy a stock at 35 $ and sell it at 40 $ or more and the stock drops to 30 $, it is easy to panic because the gap between your goal and reality widens. The investor then looks to sell while he still can. The lack of control over emotions is one of the reasons why most investors would be better off investing in index funds.

To ignore the irrational movements of the stock market, I invest in growing dividends. Market swings only represent opportunities to buy quality stocks at a good price. A falling price is a margin of safety against bad fundamental analysis or future problems with the company. With falling prices I can also buy more stocks with the same amount of money. And more stocks means more dividends.

Stock prices don’t mean much to me, other than buying them at a lower price. I have no intention of selling them to fund my early retirement, so their price doesn’t matter to me. As long as companies don’t cut their distributions or radically change their business models, I’m happy to continue collecting dividends. I reinvest them now, but I’ll use them to pay for my expenses later. That means I have little concern about the emotional reactions of the broader market.

2. Growing dividends force me to bet on companies with proven quality. It’s difficult for a company to pay dividends for decades while increasing them every year. There are natural disasters, economic cycles, changes in consumer tastes or government regulations, taxes, product recalls, competition, patent expirations, and infrastructure maintenance. Many other things can hurt a company’s ability to pay, let alone increase, a dividend for 10, 20, or 50 years.

Only companies with fantastic products, prudent use of capital and a focus on shareholder returns can sustain such dividend histories. A company like Coca-Cola (KO) has weathered the trifle of two world wars, the Great Depression, three oil shocks, the fall of the WTC towers, the financial crisis following the subprime mortgages, followed by the government debt crisis... High-quality companies overcome failures and continue to create value for shareholders in the long term. They continue to pay, and increase dividends over very long periods. The latter are tangible proof that the company is working properly, without resorting to accounting tricks.

Sure, I could invest in a hot stock of the moment like Netflix, Inc. (NFLX) or Facebook Inc. (FB). But they would have to be able to survive big economic changes while increasing their stock price, since they don't pay dividends. They don't have a long history to speak of, but they are very trendy. So that must count for something. And, they are relatively cheap, just think... FB currently has a P/E of 183 and NFLX has a P/E of 316. Why buy a quality company like KO, whose stock currently "forces" an investor to pay 22 times earnings when you could pay nearly 183 times earnings for an unproven company like FB? Plus, the old KO is paying you to own it, while the kid Zuckerberg gives you nothing.

3. A quality company's dividend growth outpaces inflation, which increases my purchasing power over time. The inflation rate over the last 10 years has averaged close to 4% per year in the US. Most of the companies I am invested in are increasing their dividends at a rate that far exceeds this figure. For example, the company Procter & Gamble (PG)  recently increased its dividend by 7%, after 59 consecutive years of increases. Compare that to bonds that pay a fixed interest rate to the holder. A 10-year US Treasury bond is paying you 1.70% per year right now. That means you're likely to receive a negative total return over 10 years if you were to hold it to maturity, due to inflation. Between that Treasury bond and PG's 3.10% yield (not including dividend and stock price growth), the choice is clear.

4. Dividend income is truly passive. Many people dream of a source of passive income that allows them to finance their lifestyle as they wish. Avoiding having to do the infamous "metro-work-sleep" until age 65, just to pay bills, that would be pretty good... Passive income means that you earn money with almost no effort. Often this notion is associated with blogging, owning your own business or investing in real estate. While all are valid sources of income to varying degrees, are they really passive?

Blogging is anything but passive. I spend many hours a week writing new articles and managing my site. Similarly, owning your own business is time-consuming, even though 3/4 of startups fail. Real estate is commonly considered a passive income source, but for that to be truly the case, you would have to leave the management to a real estate agency. However, these companies eat up a portion of your profits, and they will contact you anyway about important decisions, like replacing certain appliances or evicting tenants.

Coca-Cola (KO) will never contact me because an assembly line has a minor problem or one of their thousands of employees has a personal problem. They will just go about their business and send me my dividends without question. Dividend income is truly passive, and even better, it is income that is completely location independent. You can retire overseas or travel indefinitely if your dividend income is sufficient. Dividends are also passive because you do not need to sell shares in order to receive income. You do not have to do anything to receive the money once you invest in a company that pays cash dividends.

5. Dividends are reliable and regular, like bills. With dividends, you have a pretty good idea of how much you're going to get, and when you're going to get them. For example, Johnson & Johnson (JNJ) has always paid dividends in March, June, September, and December (usually around the 13th of each month). And you know that JNJ is going to send out 0.66 $ quarterly dividends as they usually do, unless they decide to increase it. The regularity of dividends, and their increase, is the perfect antidote to bills that come in just as regularly. If you use your dividends to pay your expenses, you'll appreciate the fact that companies are paying you a portion of their profits on a regular and reliable basis. Contrast that with the real estate example. A tenant who no longer pays their rent, an apartment that sits empty, or something that needs to be repaired on the property... nothing very pleasant to deal with.

Conclusion

Growing dividends allow you to invest without stress, without panicking and without having to work too hard. The strategy is viable, sustainable and offers solid total profitability over the long term. The resulting passive source of income allows you to finance an early retirement. Do you need more?

Source : http://www.thediv-net.com/2013/05/why-i-love-dividend-growth-investing.html