It is close of five year now that I have been a long term buy and hold, and dividend growth focused investor. When I meet friends, acquaintances, or colleagues, on many occasions the discussion starts from what’s market doing today and steers towards trading/investing is nothing but a poker game. I get a sense that many of these folks think that buying (and selling) stocks is just a gamble of some kind. Irrespective of this, I believe both, trading and investing, have their own set of pros and cons depending upon what context an individual is looking at it. In the end, both trading and investing is done to make money. Some use approach of capital appreciation, some use dividend income, some do trades to generate income. The key is to have a plan and execute it with consistent results.
When it comes to dividend investing, many individuals think of high yields (perhaps Cramerica syndrome!). It shows lack of patience and tendency to read too much into the business media. They do not understand dividend growth and sustainability.
There are two very significant aspects that investors need to understand about dividend growth investing and sustainability. These are (a) quality of dividends; and (b) potential for capital appreciation.
- Quality of dividends is related to how and from where the company is paying dividends. Good quality of dividends from companies that consistently generates cash from selling products or services, manages dividend with payout ratio, prudent uses capital for growth, and remains focused on its core competency. It is ideal to have everything in a company, but ideal situations and scenarios are either in short supply or not practical. Occasionally, companies will have issues and stumble, but those should be short lived. As long as quality of dividends are good, I believe the dividends are sustainable. These dividends add to the total return.
- Potential of capital appreciation is related to individual’s cost basis and future growth in value. Buying a stock at fair value builds-in a level of safety margin. Furthermore, I believe as the company grows and expands, it will grow its earnings and hence the dividends will grow. This growth in the company is bound to result in value over a period of time (and hence capital appreciation).
Thus, the key is to invest in companies which can grow its operating cash flow with consistency and can sustain it. A company that consistently generates cash is likely have to less downside risk. Even if they do get affected by market downturns, such companies experience less downward pressure. In addition, the continued dividends keep adding to the total returns. Examples of such companies are Proctor and Gamble (PG), Johnson and Johnson (JNJ), Becton, Dickinson and Company (BDX), T. Rowe Price Group (TROW), Sysco Corporation (SYS), Emerson Electric Company (EMR), Dover Corporation (DOV), and Jonn Wiley Sons (JW.A).
Dividend investing does not mean focus on high yield only. It is about consistency and sustainability which inherently focuses on total returns.