Dividend Champions

For the dividend investor, Dividend Champions are an essential part of the portfolio, and solve the primary problem with investing in dividend stocks.

Dividends are a distribution of profits, where a company’s board of directors decides to give its current shareholders cash from the company’s profits. They offer the investor, often quarterly, cash in proportion to the number of shares owned. This helps with the issue of risk associated with owning the stock, as the investor receives cash in lieu of hopeful results at a later time.

In researching why some argue against including companies that offer a dividend within one’s portfolio there are a number of recurring issues. For instance, some say that there may be a tendency for the investor to chase high dividend yields. I will explain below the risk of looking only at that single aspect of a company and for now note that proper diligence always needs to be performed by any prudent investor.

It was also noted that companies that pay dividends are not usually high-growth leaders. High growth companies normally retain their earnings so that they can be reinvested back into the company, so their profits are better used that way. Of course, there are exceptions, like Microsoft and Apple, but generally speaking companies that offer a reasonable dividend offer what are considered to be value stocks.

The reason to not invest in companies that offer a dividend

There is one legitimate reason to not purchase companies for the dividend and that is that dividends are not guaranteed. One might see that a company has offered a specific dividend in the past but that dividend can be cut or even discontinued. There are numerous examples of this problem.

General Motors was a reliable company for many years, but in the mid-2000s they hit a snag. As the price of the stock fell, the dividend yield shot up to 10%, which sounded like a very attractive offering. After all, making an easy 10% on one’s investment is an attractive possibility. However, as oftentimes is the case, this was not something that could last long, and in 2006 the dividend was cut in half. Two years later the dividend was suspended completely.

Imagine regularly going to an amusement park where a particular ride is the big attraction, one that you ride each time you visit. Then the park announces that they have removed the ride. With your favorite ride no longer available, not only will you probably decide to go somewhere else, but that will also be the case with many people. So with fewer people going to the park, less revenue is collected, more rides may close, and the cycle could continue until the park closes.

The same sort of thing can happen with companies that cut their dividend. Since the dividend is part of the calculation one makes when evaluating a stock, if the dividend is cut or removed then there is more reason for people to sell, less reason for people to buy, and a certain drop in the value of the stock.

As dividends are not certain, the risk factor that the dividend may be cut makes the dividend less attractive. This risk factor needs to be taken into consideration when evaluating a company, so that 2.5% dividend yield one might be counting on could get cut in half, or worse.

The solution to the problem of investing for the dividend

Although past performance is not surety of the future, a long history of positive dividend growth can give one confidence that there is a greater chance that the performance will be retained. A company that has offered a dividend for only a few years cannot give us certainty as to what might happen to the dividend in the future.

A company that has not only maintained a dividend but has also increased it every year for at least 25 years can give one confidence that this is something that is more likely than not to happen far into the future. The only question is how to find these companies.

Back in 2007 Dave Fish began to offer a spreadsheet that listed companies that met this criteria and called them Dividend Champions. With his passing in 2018 the task was given to Justin Law, who now maintains the list. Over the years the list has expanded to include not only companies that have increased their dividend for at least 25 years, but also Contenders (10 to 24 years) and Challengers (5 to 9 years). Each list also comes with a wealth of statistics for each company.

We are at a point in time where the past 25 years have experienced the Dot-com Bubble and the 2008 Stock Market Crash. Both were major events that placed a huge burden on companies and especially with the latter, there was every reason for a company to at least not increase their dividend. However, the Dividend Champions in today’s list continued to raise their dividend even throughout these crises. That fact can give one increased confidence that these champions will continue to increase their dividend in years to come.

An alternative to Dividend Champions are the Dividend Aristocrats, which are limited to members of the S&P 500 index. This is a list of companies that are filtered to include only the 500 largest companies in the United States stock market.

Dividend Champions are limited to companies in the United States, but over the years others have decided that companies outside the country should also be noticed so The DRiP Investing Resource Center includes:

  • Canadian Dividend All-Star List
  • European Dividend Champions
  • Eurozone Dividend Champions

Dividend Champions solve the primary concern of buying companies with dividends by offering a list of those that have not only maintained, but increased, their dividend for at least 25 straight years (more than 25 companies have a streak of at least 50 years!). With this history of dividend increases, Dividend Champions reduce the risk to the dividend investor associated with maintaining the dividend.

Understanding Dividend Yield

Understanding the definition of the dividend yield is the easy part, what it means to the dividend investor is a matter of the current inflation rate and the reasons for purchasing a company.

When evaluating stocks there are many metrics that can be used, some have great importance, and others have importance only in specific cases.  The dividend investor looks at the yield to understand what their cut of the proceeds will be.

Understanding the definition of the dividend yield is fairly simple, understanding what the yield means to the investor is another issue.

The dividend yield is the amount of the annual dividend payment divided by the stock price expressed as a percentage.  For instance, one of my favorite companies, AFLAC, offered quarterly payouts in 2019 of 27 cents each, so for every share owned, $1.08 was returned as a dividend.  AFLAC’s stock price, as I write this (21 Dec 19), is $53.14.  So $1.08 / $53.14 *100 = 2.3%, the dividend yield.

As the dividend yield is a comparison with the price, if AFLAC’s stock price moves up to $60 then the dividend yield will fall to 1.8% or if the price drops to $50 then the yield will rise to 2.16%.

Related to this is the dividend payout ratio, which is also important to understand.  The dividend payout ratio is a ratio of the total amount paid in dividends to the net income.  When a company makes a profit, that money goes toward dividends, debt reduction, cash reserves, and reinvestment back into the company.  The dividend payout ratio gives one an idea how much of the profit is being returned to the owners of the company, as opposed to being used for company purposes.

Understanding the implications of the dividend yield are much more difficult than understanding its definition.  After all, dividend yield is just a number, but how does one know if it is a good number.  And is there such a thing as a good dividend yield?

Unfortunately, the answer is one that we all too commonly hear – It Depends.

Reflexively one might think that the higher the dividend yield the better, after all, the higher the yield the higher the return.  But reality pokes its finger into this thinking when one realizes that the highest average dividend yield ever was during the Great Depression, not one of the favorite times for investors.

Thinking about the reason for a dividend in the first place might offer a hint as to what a good yield might be.  Companies oftentimes offer dividends to attract investors and create a demand for their stock.  This means that the dividend yield needs to be attractive enough to convince the investor to purchase the company’s stock.

If one if looking for a place to put their money where it would offer a return, saving accounts and money market funds offer so little that the only value they have is that the funds are ensured not to go down.  Of course, as of this writing the average money market interest rate is 0.18% and the inflation rate is 2.1%, so one actually loses about 1.9% with such an investment.

But that gives us an idea as to what the minimum dividend yield should be if one is purchasing the company solely for the dividend.  If the dividend does not keep up with inflation then one could actually lose money while gaining it.

With the current inflation rate of 2.1% that might be a good starting point for what one might consider to be a “good” dividend yield.

However, as stated above, this would be the case for one who is purchasing only for the dividend.  The company’s stock price should also be taken into consideration.

There is no magic formula for this – actually, some tout such formulas but I have seen these claims fall apart too many times.  Due diligence for company selection is beyond the scope of this dividend website, but I can offer a bit of research I have found helpful.

Although past performance is no guarantee of the future (how many times have we heard that, and it is true), I do like to see where the company has been, and I will use the example of AFLAC.

Looking at the historical stock price of this company we can see that over the past 10 years the average annual return with dividends reinvested is about 11%.  Since the company’s dividend yield is about 2% we can see that even if it was considerably lower, this would be an excellent company to select.  The fact that AFLAC is a Dividend Champion gives one confidence that the dividend has an excellent chance of sticking around in the future, which also speaks to the stability of the company.

Comparing the dividend yield to the current inflation rate is a good starting point for one when considering the purchase of a company when the expectation of the dividend is a major reason for the purchase.