Dividend Growth Investing

There are two ways to build a stream of dividend income. You can buy something that pays a lot today, or you can buy something that pays a modest amount today and raises it every year. The second approach, dividend growth investing, is slower to start and often far more powerful in the end.

The snowball

A dividend that grows 8% a year doubles about every nine years. Hold it for 27 years and it has doubled three times: eight times the income you started with, without adding a penny. Compare that with a stock paying a bigger but frozen dividend. Try it below.

With the starting settings, the grower pays less than half as much as the high yielder at first, overtakes it in year 14, and pays far more from then on. Over 30 years it delivers more total income too, and in real life its share price has usually grown alongside the dividend, which the chart doesn’t even count.

How long until your dividend doubles?

A handy shortcut: divide 72 by the growth rate to get the rough number of years it takes to double.

Inflation has averaged around 3% a year in the US over long periods. A dividend growing faster than that is raising your real spending power. A dividend that never grows is quietly losing about a third of its buying power every decade or so.

Yield on cost

Long-time dividend growth investors like to talk about their yield on cost: today’s dividend divided by what they originally paid.

It’s a satisfying number, and it shows how patience pays. Just don’t use it to make decisions. The question for any investment is always what it will do from today’s price, not what you paid years ago.

What drives dividend growth

A company can grow its dividend in only two ways:

1. Earn more. If profits grow 7% a year and the payout ratio stays the same, the dividend can grow 7% a year forever, or for as long as the profits keep growing.
2. Pay out a bigger share of what it earns. Raising the payout ratio from 40% to 60% lets the dividend grow faster than profits for a while. But that tap runs dry: you can’t go past 100% for long.

This is why a company growing its dividend 10% a year while its earnings grow 2% is living on borrowed time. Watch both numbers. When dividend growth is far ahead of earnings growth, slower raises (or worse) usually follow. You’ll see how to check this in How to Analyze a Dividend Stock.

What dividend growers look like

Companies that raise their dividends year after year tend to share a profile: a business people need in good times and bad, pricing power, a strong balance sheet, and a payout ratio that leaves room. Many are household names. The most famous lists of them, the Dividend Aristocrats and Kings, are the next two lessons. Here are a few well known growers and dividend growth ETFs, with live figures:

Balancing yield and growth

The best dividend growers often have low starting yields, sometimes under 1%, because the market already prices in their growth. At the other end, some high yielders barely grow. A popular rule of thumb among dividend investors, sometimes called the Chowder rule after the forum member who popularized it, adds the two together:

A stock yielding 3% with 9% growth scores 12. One yielding 5% with 3% growth scores 8. For slow and steady sectors like utilities, people often accept a lower bar, around 8. The logic: if a company’s valuation stays roughly the same, its long-run return is about its yield plus its growth rate. It’s a quick filter, not a verdict.