Topic: Dividend Stocks

Dividend growth stock investing can add to your portfolio returns—here’s why

October 23, 2019|by Scott Clayton

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Integrate dividend growth stock investing into your portfolio strategy and you’ll expand your odds of investment success

Growth dividend stocks are a unique type of investment that can deliver strong earnings quarter after quarter—and yet at the same time pay dividends. Growth stocks can hold the potential for greater gains than conservative selections. However, they typically can also expose you to a higher level of risk—whether or not they are dividend-paying stocks.

Nonetheless, we feel that dividend growth stock investing can be a part of your portfolio if your stock picks have strong business models, balance sheets and so on.

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Look closely at balance sheets to succeed in dividend growth stock investing

A balance sheet is a financial statement that gives a snapshot of a company’s assets, liabilities and shareholders’ equity. Investors use this data to determine how sound a company’s finances are—and also to discover if it has any “hidden assets.”

Certain types of assets on a balance sheet might have actual market values well above historical values. For example, when a company buys real estate, the purchase price goes on its balance sheet as the historical value of the asset. Over a period of years or decades, the market value of that real estate may climb substantially. But the purchase price remains unchanged on the balance sheet.

At times, in fact, the hidden value in a company’s real estate can come to exceed even the market value of its stock. This hidden value may only become apparent to investors when the company upgrades the use of the real estate. For example, a merchandiser might repurpose a parking lot to build a shopping mall with a residential condo tower on higher floors, and a parking garage down below. Similarly, balance sheets often fail to assign any value to brand names, even those household names that have built up multitudes of loyal customers over the years.

Use a dividend growth stock investing strategy that focuses on quality to bring stability and profits to your portfolio

As with conservative dividend-paying stocks, dividend growth stocks offer investors an added measure of security. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake—either the company has the cash to pay them or it doesn’t.

However, at the same time, it’s important to avoid judging a company based on the fact that it pays a dividend. Nor should you be tempted solely by a high dividend yield (the percentage you get when you divide a company’s current yearly payment by its share price). That’s because an usually high yield can be a danger sign—for example, it may foreshadow a dividend cut.

That’s why we look beyond dividend yield when making investment recommendations, and look for dividend stocks that have an established business and at least some history of building revenue and cash flow.

Portfolio diversification lets you avoid too much exposure to any individual sector

We advise against a so-called “sector rotation” approach to investing; this is when you try to hop from sector to sector.

Few sector rotation strategies succeed over long periods, because you’ll need to guess right twice. In other words, you have to pick the top sectors, and you need to pick the stocks to rise within those sectors. Consistently succeeding at both is extremely difficult.

There are many theories about which sectors will outperform at any given stage in the economic cycle. But trying to pick winning sectors—and staying out of other sectors—seldom works with consistency. Practitioners of sector rotation often wind up with heavy holdings in the worst-performing sectors. This can be devastating to your portfolio, even if you confine your investments to well-established companies.

Rather than using sector rotation to try to beat the market, you should pick a good selection of stocks right from the outset. After you’ve decided to invest in stocks, remember to spread your funds out across all or most of the five main economic sectors. This way, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or changes in investor opinion.

By diversifying across the sectors, you also increase your chances of stumbling upon a market superstar—a stock that does two to three (or more) times better than the market average. These stocks come along every year.

Use our three-part Successful Investor approach for your best investment results

1. Invest mainly in well-established, dividend-paying companies;
2. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; the Consumer sector; Finance; Utilities);
3. Downplay or avoid stocks in the broker/media limelight.

Some investment analysts believe that screening stocks for a high yield is a weak way of finding dividend growth stocks. What are your thoughts on this?

Even when they offer dividends, growth stocks can still carry more risk than some conservative selections. How do you find this impacts your investing strategy?