Dividend Growth

The three pronged approach to building wealth.

Dividends are my favorite investing topic to discuss because I love the idea of earning money for no work. I'm a firm believer that in order to build wealth you have to use your earned income to buy income. Dividend growth investing is the most effective investment style for the majority of investors looking to the stock market to build wealth. I'm going to show you the three ways that dividend growth investing will build wealth in your portfolio.

First, we must understand what dividends are and what it communicates to the investing community. A dividend is the payout of cash the business earned but doesn’t need to continue and grow the operation. A company does this when:
1️⃣They can’t reinvest the money back into the business and earn a high return on the investment.
2️⃣Management has confidence that the operation will continue to earn excess cash in the future. 
When a business pays dividends, they establish an implicit contract with investors as there is an automatic assumption the dividends will continue and possibly grow.

Stock Appreciation

When you buy a stock, your hope is that the stock will grow in value. This is no different when the business pays a dividend. Investors can mistakenly invest in the high dividend paying stocks, ignoring the business performance (Dividend Traps). Dividend investing doesn’t negate the need to invest in quality businesses that consistently grow their profits. The stock price of a business trends with the profits of the business. Investing in quality businesses allows for the dividend to be safe. Meaning it is likely the dividend payout will continue and even increase.

Dividend Growth

Businesses typically grow their dividends each year. This allows investors’ benefit to coincide with the continued success of the business. This incentivizes investors to buy and hold the stock over a long period of time to reap the benefits of the company’s success. Dividend growth is a form of compounding that can’t be overlooked. Think of the benefit of the stock price growing along with the dividend payout!

Reinvest Dividends

Reinvesting dividends is the most important action you take when investing. From 1960-2022, 69% of the total return of the S&P500 can be attributed to reinvested dividends. Most people desire to have more money invested than they currently do. Reinvesting dividends is a way to build wealth as this gives the investor more equity in the market for free.

If I receive a dividend and reinvest it, I now have more equity in the business. The more equity I have, the more dividends I receive. This creates a compounding effect separate from the stock growth. Reinvesting dividends is the key to building wealth in the stock market for this reason:  If the stock price and dividend payout never increased, your investments can still grow at an accelerated rate with reinvested dividends.

Warren Buffett on Dividends:

In the 2022 letter to shareholders, Buffett discussed how impactful dividends have been to his success.

“… The total cost was $1.3 billion…The cash dividend we received from Coke in 1994 was $75 million. By 2022, the dividend had increased to $704 million.”

That’s a dividend yield that went from 5.7% of his investment to approximately 54%! Imagine investing and receiving $0.54 on every dollar you’ve invested! That’s the power of holding dividend stocks!

“American Express is much the same story. Berkshire’s purchase of Amex were essentially completed in 1995…also cost $1.3 billion. Annual dividends received from this investment have grown from $41 million to $302 million. Those checks, too, seem highly likely to increase.”

This dividend increased from 3.1% to approximately 23%!

Conclusion

The dividend growth investing plan is simple:
Invest in quality businesses - Businesses that are growing their earnings and have the ability to pay and increase their dividend.

Hold the dividend for a long period of time - We see that the greatest investor of all time is so because of the discipline to buy and hold quality businesses.

Reinvest the dividends – Receive dividends > Reinvest Dividends > Repeat.
The goal is to have more equity in the market. You accomplish this by putting more of your earned money in the market and reinvesting the unearned income from dividends.