A guest post by Josh Arnold for Sure Dividend
Anyone that is looking to compound their wealth over time must make choices about how to best accomplish this goal. This includes assessing how much the investor can afford to put away for future growth while balancing living expenses. After all, there are countless ways to invest, including cryptocurrencies, US government bonds, corporate debt, preferred stock, and of course, common stocks.
Investing in dividend growth stocks has been proven to be a great way to compound wealth over the long-term. The best way to do this is to find companies that have a history of thriving during recessions, averting competitive threats, and having management teams that are willing to return cash to shareholders.
We see the clearest path to wealth compounding as investing in high-quality dividend growth stocks, such as the Dividend Kings, which have raised their dividends for at least 50 consecutive years. In this article, we’ll take a look at why one would want to invest in dividend growth stocks, and some examples of companies we like today.
Why Dividend Growth Stocks?
The case for investing in dividend growth stocks is compelling, and has decades of returns to back it up. The idea is simple; buy the stocks of companies with high-quality, durable businesses, at fair value or below. This strategy is the one that some of the world’s most successful investors have used over the years to create enormous wealth, including Warren Buffett.
How do we find high-quality, durable businesses? Companies that can stand the test of time need to have durable competitive advantages and recession resilience, at a minimum. These characteristics make for a company that can sustain – and sometimes even grow – profits during periods of economic weakness, and this can only occur if the company’s products and services are better than that of the competition.
Over time, companies that have these advantages tend to see more sustainable profit growth, which then leads to the ability to pay shareholders ever-rising dividends over time. These are very favorable traits, and businesses that have them will likely produce strong capital appreciation over the years. However, for a great dividend growth stock, there’s another ingredient that is necessary, and that is a management team that is willing to return excess cash to shareholders.
For companies that are still focused on building for future growth, shareholders are unlikely to see a high level of cash return because the business is instead investing that cash. Thus, for a great dividend growth stock, the business must be mature enough that there is sufficient excess cash that management cannot profitably invest in it.
If we use these criteria to select stocks, the process of going about actually investing in dividend growth stocks is pretty straightforward. The investor needs only to select a broker, fund the account, and make their purchases. We favor adding a little to our favorite dividend stocks every paycheck, every month, or at some regular interval that makes sense for the individual. This avoids the temptation to trade in and out of the market, and allows the investor to dollar-cost average into dividend growth stocks over time.
Now, let’s take a look at some examples of great dividend growth stocks.
High-Quality Dividend Growth Stocks
- Lowe’s Companies (LOW). Our first example of a great dividend growth stock is Lowe’s Companies (LOW), the operator of the ubiquitous chain of about 2,000 home improvement stores across the US. Lowe’s is a terrific example of a company that has a sustainable competitive advantage, which generates rising profits, and has a management team that is willing to return that cash to shareholders.
Lowe’s operates in what is essentially a duopoly with rival Home Depot (HD) in the home improvement space, so Lowe’s has plenty of scale. In addition, the segment of home improvement has seen enormous growth in demand over time, meaning there was plenty of business available for all competitors. Lowe’s has some susceptibility to recessions given it is reliant upon construction and home improvement spending, but its resilience is evidenced by its outstanding 60-year streak of dividend increases, making it a Dividend King.
Not only has Lowe’s done a great job of raising its dividend from a longevity perspective, but its increases have averaged more than 20% annually in the past decade. From a dividend growth perspective, this is about as good as it gets, particularly for a Dividend King.
- Pentair (PNR). Our second stock is Pentair (PNR), maker of a wide variety of water solutions globally. The company makes consumer-oriented pool equipment and accessories, including pumps, filters, heaters, lights, and various other products needed for home pools and spas. In addition, it has a commercial business that makes similar equipment for a wide variety of uses, including food and beverage, water supply and disposal, valves, spray nozzles, gas recovery, and more.
Pentair isn’t a Dividend King, but it does have a very impressive history of 45 years of consecutive dividend increases. That means that the company’s ability to withstand recessions is well proven, and it also helps that Pentair is a big player in small markets. In other words, while Pentair’s absolute size of about $4 billion in revenue and just over $8 billion in market capitalization doesn’t make it a big stock by any means, it has strong market share in the areas in which it competes. This is powerful, and it is a big reason why Pentair has been able to increase its payout to shareholders for nearly half a century.
Pentair’s growth outlook and very low dividend payout ratio – which is less than a quarter of earnings – support many more years of dividend increases.
Final Thoughts
Buying stocks like these and holding them over the long-term is a proven strategy to produce sustainable wealth creation over time. The holding list of Dividend Kings is a great place to start when looking for such stocks, and we see Pentair and Lowe’s as examples of great companies that are willing and able to grow shareholder income over time.
Josh Arnold is an independent equity analyst and a writer on the subject of dividend stocks. His work can be seen on Sure Dividend, as well as other financial sites such as Seeking Alpha.
