Value Investing

Why The Dividend Aristocrats Are Good Investments To Generate Long-Term Wealth

Investing can seem overwhelming, particularly for beginners. But for those willing to put in the time, investing can be one of the most rewarding financial moves a person can make.

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For most, the destination of investing is financial independence. The stock market is an excellent vehicle to accomplish this. More specifically, dividend growth stocks have generated strong returns over the past several decades.

At Sure Dividend, we routinely discuss the Dividend Aristocrats. These are stocks in the S&P 500 Index, with 25+ consecutive years of dividend increases. You can see all 51 Dividend Aristocrats here.

For investors interested in long-term dividend stocks, the Dividend Aristocrats are a great place to look. Fortunately, in the Internet age, an abundance of information is available at investors’ fingertips.

There are plenty of tools that can give investors a platform to ask each other questions. Recently, a Quora user asked “Would allocating my money among the ‘dividend aristocrats’ be a good investing strategy to generate income and wealth”?

Our answer to this question is a resounding ‘yes’. This article will provide a detailed look at why the Dividend Aristocrats are a great way to build wealth.

Dividend Aristocrats Overview

There are many different types of stocks an investor can purchase. Stocks come in all shapes and sizes—from small caps to large caps, across every economic sector. History has shown that the stock market has consistently outperformed other asset classes, over long periods of time.

For example, noted Wharton professor Jeremy Siegel calculated that $1 invested in the stock market in 1802, would have grown to $8.8 million in 2003. Meanwhile, the same $1 invested in bonds would have grown into $16,064 by 2003, while $1 in gold would amount to just $19.75.

Not all stocks choose to pay dividends to shareholders. On the other hand, many stocks do pay dividends, and these are the types of stocks we focus on at Sure Dividend. In particular, we frequently recommend investors begin their search with the Dividend Aristocrats.

Just about 1 out of every 10 stocks in the S&P 500 qualifies as a Dividend Aristocrat. In other words, 90% of the large-cap market index do not currently qualify, which speaks to the exclusivity of the Dividend Aristocrats.

The list of Dividend Aristocrats is balanced across market sectors.

Dividend Aristocrats
Source: S&P 500 Fact Sheet

The highest allocation of the Dividend Aristocrats is in the consumer staples, industrials, and healthcare sectors. This should come as no surprise, as these industries enjoy steady product demand from year to year, even during recessions.

Consumer goods, industrial components, and healthcare products are used each day by millions of people and businesses. They are vital to the normal functioning of the economy, which naturally allows for the industry leaders to raise their dividends each year.

And, dividends require a certain level of discipline on the part of company management teams. Companies that have maintained long track records of dividend growth understand how important the dividend is to their investors. This makes it less likely they will embark on wasteful spending projects, or pursue ’empire-building’ acquisitions that do not benefit shareholders.

To answer the above question posted on Quora, the Dividend Aristocrats are a great investment strategy to generate long-term wealth. Not only have the Dividend Aristocrats outperformed the broader market index over the past 10 years, but they have done so with lower volatility along the way. In other words, the Dividend Aristocrats provide higher returns for less risk, than the average stock in the S&P 500.

The Importance Of Dividend Growth Stocks

According to Standard & Poor’s, dividends have accounted for one-third of all equity returns since 1926. And, in the past 10 years, the Dividend Aristocrats have collectively returned 11.6% annual returns, on average. By contrast, the broader S&P 500 Index has returned 8.3% per year, in the same period.

Furthermore, the Dividend Aristocrats exhibit lower volatility. In 2008, the worst year of the Great Recession, the Dividend Aristocrats Index declined 22%, while the S&P 500 declined 38%.

SP Aristocrats

Source: S&P 500 Fact Sheet

In times like these, with the stock market racing to record highs, it is easy to forget about the importance of dividends. Dividends also help provide a cushion when the market declines. Since the Dividend Aristocrats are quality businesses that remain profitable, even during recessions, investors can avoid the stocks that bear the greatest damage during economic downturns.

The Great Recession was particularly difficult, but the Dividend Aristocrats at least provided investors with rising dividend income during the downturn. Rising share prices are always welcome, but dividends provide a real return. An investor can choose to take their dividend in cash, and spend it on whatever they choose.

Or, investors can reinvest dividends back into new shares of a stock, which unleashes the power of compounding interest.

It is rumored that Albert Einstein once called compounding interest “the most powerful force in the Universe”. Regardless if it is true, it is hard to argue with the reasoning. Reinvesting dividends allows shareholders to increase the number of shares they own. In turn, this results in higher dividends, which can then be used to purchase more shares, and so on.

In a way, reinvesting dividends has a ‘snowball effect’ on building shareholder wealth over many decades.

Investing in all 51 Dividend Aristocrats might not be feasible for every investor. The next section of this article will discuss three of the strongest Dividend Aristocrats, to get your research started.

Real-Life Examples Of The Power Of Dividend Growth

To demonstrate the power of dividend growth investing over long periods of time, investors can consider healthcare giant Johnson & Johnson (JNJ), consumer products manufacturer Procter & Gamble (PG), and beverage behemoth Coca-Cola (KO).

All three stocks are Dividend Aristocrats. In fact, they are also members of an even more exclusive club than the Aristocrats—the Dividend Kings, a list of 22 stocks with 50+ consecutive years of dividend increases. You can see all 22 Dividend Kings here.

Consider the returns these stocks have generated over the past 30 years, had investors simply bought and held, while reinvesting dividends along the way. All historical prices have been adjusted for splits and dividends.

December 14th, 1987 Closing Price December 14th, 2017 Closing Price Compound Annual Returns
J&J $2.51 $141.65 14.4%
P&G $2.58 $91.00 12.6%
Coca-Cola $1.29 $46.03 12.7%

Source: Yahoo! Finance

As you can see from the table, all three stocks provided double-digit returns each year, including reinvested dividends. And before you think these are rare examples that cannot be repeated again, consider that these were not exactly speculative start-ups at the time.

Even 30 years ago, J&J, P&G, and Coca-Cola were all established businesses, with leadership positions in their respective industries. They were already “blue-chip” stocks three decades ago, which proves investors do not need to gamble on risky stocks with questionable business models, to earn satisfactory returns.

J&J, P&G, and Coca-Cola have not only provided above-average returns over the past 30 years, they have done so with less volatility than most other stocks. They are 3 of the 15 least-volatile Dividend Aristocrats.

Consider how fast your money can compound with these kinds of returns. To demonstrate, investors can utilize the “Rule of 72”, a quick-and-easy way to determine how long an investment will take to double.

For example, if a stock earns a 12% annual return, an investor will double their money every six years. That means, if an investor purchased $10,000 worth of each stock, and generated 12% annual returns, in 30 years the portfolio would be worth approximately $960,000.

Stocks For The Long Haul

J&J, P&G, and Coca-Cola might not be the most exciting businesses, but clearly there is something to be said for the tried-and-true. They should have little trouble continuing to raise their dividends each year, for many years to come. All three companies have strong brands, highly profitable business models, and potential for future growth.

J&J has all these qualities. It has been in operation for 130 years, and has raised its dividend for 55 years in a row. It is one of the world’s largest healthcare companies, with annual revenue above $70 billion, and more than 250 subsidiary companies.

It has three operating segments:

  • Pharmaceuticals (49% of sales)
  • Medical Devices (33% of sales)
  • Consumer Health Products (18% of sales)

J&J leads to steady cash flow and growth each year. J&J has strong brands across its three core operating segments.

JNJ Overview

Source: Q3 Earnings Presentation, page 1

J&J’s diversified businesses complement each other well. In 2016, earnings-per-share increased 8%. ValueLine analysts expect J&J to grow earnings by 20% in 2018. From 2020-2022, earnings-per-share are expected to rise by another 37%.

Similarly, P&G is a diversified company, with leading brands across its various product categories. The Dividend Aristocrats typically possess significant competitive advantages, and P&G is no different.

P&G is a global consumer products giant. It sells its products in over 180 countries around the world. Approximately 55% of sales are derived from outside North America. The company generates over $65 billion in annual sales.

P&G’s portfolio includes 65 brands, in 10 key categories.

PG Brands

Source: Barclays Global Consumer Conference, page 8

P&G has increased its dividend for 61 years in a row. It has paid a dividend for nearly 130 years. No company can maintain over 100 years of dividend, without sustainable competitive advantages.

For P&G, its main competitive advantage is its brand strength. It retains its brand positioning with advertising and product innovation.

The company spends $7 billion each year on advertising, and another $2 billion per year on research and development. Top-quality products and brand recognition allow for steady growth each year.

P&G’s currency-neutral revenue increased 2% in the most recent fiscal year. But thanks to cost cuts and share buybacks, earnings-per-share increased 7%.

Going forward, ValueLine analysts project another 7% earnings growth in 2018. From 2020-2022, P&G is expected to grow earnings by 49%.

The Ability To Grow In Good Years And Bad

Another benefit of the Dividend Aristocrats is that many of them have the ability to generate earnings growth consistently, even during challenging years. Since they are highly profitable and enjoy economies of scale, they can cut costs to improve their margins.

Being profitable each year means companies can also repurchase their own stock, which reduces the number of shares outstanding. These actions help grow earnings-per-share, even if revenue does not grow.

Coca-Cola is a good example of how a strong brand and economies of scale can allow for earnings growth, even during challenging times.

According to Forbes, Coca-Cola is the 5th most valuable brand in the world, with a brand value of $56 billion. Coca-Cola sells over 500 brands, in more than 200 countries.

KO Market

Source: 2017 Investor Day Presentation, page 4

Coca-Cola has 21 brands that each bring in $1 billion or more in annual sales.

However, Coca-Cola is struggling to grow sales in this climate, since soda consumption is declining.  In fact, soda consumption in the U.S. has fallen for more than a decade, and is currently near a 30-year low.

In response, Coca-Cola has invested heavily in its still beverage portfolio, which includes water, juices, and ready-to-drink teas. This will help it return to growth in the U.S.

Moreover, Coca-Cola is a global company. It has plenty of growth opportunities outside the U.S. The company envisions the global beverage market to grow at a 4% compound annual rate through 2020.

Thanks to its distribution and scale, Coca-Cola is still growing earnings-per-share. In 2016, adjusted earnings-per-share increased 5%.

According to ValueLine, in the past 10 years, Coca-Cola grew earnings by 4% per year. Analysts expect another 3% growth in 2018, which will be more than enough to continue increasing its dividend.

Final Thoughts

There are thousands of publicly-traded stocks that an investor can purchase. With so many dividend stocks to choose from, selecting among them can seem like a difficult task. But it is much easier than it seems, because it is possible to narrow down your search to the “best-in-class” dividend stocks.

The Dividend Aristocrats are the embodiment of the best stocks the market has to offer. They have durable competitive advantages, and have demonstrated the ability to withstand recessions. Year after year, they continue to churn out consistent profits, and reliable dividends. Even better, they raise their dividends each year, which unleashes the magic power of compounding interest.

The three Dividend Aristocrats presented here—J&J, P&G, and Coca-Cola—are just a few examples of high-quality Dividend Aristocrats. There are dozens more that can help an investor build sustainable wealth over the long term.

Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected]

Article by Bob Ciura, Sure Dividend