By: Dividend Sensei
Saving and investing for one’s future is one of the most important things a person can do in today’s unpredictable, and hectic world. This is why it’s more important than ever to not just save, and invest as much as one can realistically do, but also do so as effectively as possible. Which is why, for those with a long enough time horizon, stocks are simply put the best way to build wealth over time. What’s more, studies have shown that dividend growth stocks are the best performing class of stocks, helping to boost your overall returns even more.
However the true power of dividend growth investing lies not just with superior returns, but in two far more important ways that this method of investing can help you achieve your financial goals, and aspirations.
The first reason dividend stocks have outperformed is that the payment of a dividend represents a superior, long-term focused, shareholder friendly corporate culture. One that must be more conservative with its capital allocation strategies. For example, companies that pay a 20% free cash flow payout ratio must naturally be more selective with how they allocate the remaining cash, once the dividend is paid. In other words, it produces an artificial scarcity, a stressor that helps keeps companies more efficient, and thus competitive in their industries. It also imposes a more conservative approach to managing the balance sheet, meaning keeping debt levels low enough to not threaten the payout during a downturn in the economy. This produces a naturally stronger capital position that helps to keep the firm alive, and maybe even growing during recessions.
However, the biggest reason why I’m such a fan of dividend growth investing is the benefits it provides to overcoming the number one problem investors face; their own psychology.
Specifically the focus on short-term price movements. As we’ve seen over the years, the market, in any given 1-2 year period, can be immensely volatile, and just plain crazy. And thanks to a psychological principle known as loss aversion, (losing a dollar hurts twice as much as gaining a dollar feels good), most people can’t help but bail out of their stocks when prices start falling. In fact, as the famous Buffett quote, “be greedy when others are fearful” makes clear, that is the exact best time to be buying, not selling.
In other words, human nature is your own worst enemy when it comes to investing success. If you want to good investor first you must conquer yourself; specifically your own fears. Dividends are immensely helpful in that quest because they refocus your mind on what counts, long-term company fundamentals.
For example, AT&T currently yields 4.7%, one of the most generous payouts of any corporate blue chip. If the price were to crash 50% (as it did during the financial crisis) then the yield would rise to 9.4%, a truly epic level. The key is the company’s strong fundamentals: its recurring business model, rivers of free cash flow, and strong balance sheet. These things all ensure that the company itself would not be in jeopardy in a 2008 style crash, and the dividend would likely remain safe.
And with a yield that spectacular, reinvesting those dividends will result in an exponentially growing number of shares, each that has locked in a yield that ensures that this capital will beat the market’s historical 9.1% CAGR total return since 1871 through dividends alone. Add in future dividend growth, (AT&T has raised its dividend 31 consecutive years), and you can see how owning this company means accessing a perpetually growing cash flow stream.
That stream can be tapped into during an emergency, or retirement, to help pay expenses, without having to sell shares. After all, you should consider your portfolio a business, and your shares are income producing assets. Ideally these assets should be rising over time, not falling due to having to sell shares. And thanks to the awesome compounding power of dividend reinvestment over time, your assets (shares) will only grow faster and faster over time, ESPECIALLY when the market falls.
In other words, dividend growth stocks turn you from a speculator in short-term share prices, into a manager of a business; a diversified income generating conglomerate with ownership stakes in America’s best corporations, and that’s focused on achieving maximum long-term exponential income growth.
When you invert your thinking in this way, then suddenly “being greedy when others are fearful” becomes much easier, because you have disconnected your thinking about stocks from the price entirely. Your focus in on the core business, and its cash flows, and how that effects the dividend security and growth prospects. The daily price fluctuations become irrelevant. In fact, you hope that the price will fall, because then you can add more shares faster, and grow your dividend stream all the faster.
In this way dividends help you to become a more disciplined, consistent, and patient investor, all factors that are essential to achieving long-term success not just in the market, but in life itself.
So I invite you to join me on an exploration of the wonderful world of dividend growth investing. On this site you’ll just get coverage and analysis of America’s best dividend growth stocks, but also information about how to improve your financial life in countless other ways. From personal finance advice about how to save money in potentially innovative ways, to how to think about, and plan for retirement. You’ll also find analysis of the economy, and markets from a common sense, long-term perspective; without any of the hyperbolic hype found in traditional media.
Welcome to DividendSensei.com; and your journey to financial independence, and prosperity.