Experienced Dividend Growth Investors Can Ignore Volatility

emotionally charged. In the short run, it’s all about how many buyers show up today versus how many sellers.  Business results take a back seat, but longer term they matter most.

The Truth About Recessions

Much of what this article is all about, is my recommendation to do all you can to keep emotions in check when making investment decisions.  It is very easy to get caught up in the hype and hysteria, especially when mainstream media bombards us with endless tales of doom and gloom. And nothing seems to strike more fear in the hearts and minds of the everyday investor than the “R” word.  Just the mere mention of the word “recession” can cause the bravest investor to go weak in their knees.

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As I previously mentioned, I believe that the Great Recession of 2008 has had a lasting negative impact on the attitudes of many investors towards common stocks. The old adage that “Wall Street climbs a wall of worry” comes to mind. Since the stock market bottomed in February of 2009, we have had four years of exceptional stock price appreciation.  Yet through it all, there’s been an endless barrage of negative prognosticators warning us of the pending collapse.  These dire forecasts continue today.

Therefore, I thought it would be valuable to put recessions into perspective. First of all, they simply represent a temporary interruption in the long-term upward business cycle of growth.  And as it pertains to the stock market, recessions normally bring with them a bear market.  However, it’s important to remember how all bear markets have ended.  Following every bear market in history has been an extended bull market. When thought of in this way, it becomes apparent that recessions are more about great buying opportunities than they are catastrophe.

Please do not take what I’m saying to imply that I do not recognize the pain, suffering and angst that recessions cause.  Instead, my goal is to simply put a recession into its proper perspective in order to help investors relieve some of the anxiety that they bring.  The most important message is that recessions do end, and that we should fear the fear of a recession more than we do the recession itself.

I offer the following hypothetical dividend growth portfolio to illuminate the veracity of my major positions about dividend growth investing and recessions.  First, I want to show that a portfolio of high-quality dividend growth stocks can fall in market value during a recession, while simultaneously continuing to increase their dividend income stream.  Secondly, I want to illustrate that these recessionary price drops most often represent extraordinary opportunities at best, and at worst simply embody a valley that shrewd investors are willing to walk through.

A Hypothetical Dividend Growth Portfolio

I offer the following 10 dividend growth stocks as an example of a hypothetical dividend growth stock portfolio that was built one year prior to the Great Recession of 2008. Therefore, the portfolio is fully exposed to the price erosion that accompanied the Great Recession. Moreover, this portfolio will illustrate how this price volatility affected annual capital appreciation, but also how dividend income continued to steadily increase in spite of price volatility.

As a few points of clarification, I’m only utilizing 10 examples so that I can provide detail on each without asking the reader to endure too much redundancy. In the real world, I would build a dividend growth portfolio comprised of 20 to 25 stocks for investors in the accumulation phase, and 30 to 50 stocks for retired investors in the distribution phase.  My logic is simple; I prefer more concentration when attempting to generate a higher total return, and more diversification when there is not enough time to overcome the risk of loss.

Furthermore, I chose the specific 10 examples for various reasons.  I wanted to include companies that were able to go through the recession with little or no damage to their business results.  Colgate-Palmolive, Family Dollar Stores, VF Corp. and Kimberly-Clark represent companies that showed little stress with their earnings growth in 2008. Consolidated Edison, Air Products & Chemicals and W.W. Grainger had a more severe earnings drop in 2008, but yet all three remained very profitable ongoing enterprises.

Illinois Tool Works and Stanley Black & Decker are two examples of companies whose earnings decreases extended beyond one year.  Nevertheless, both companies remained profitable and increased their dividends, albeit at a lower-than-typical rate of growth. Finally, I included Franklin Resources as an example of a financial that suffered more recessionary damage than the other nine, but was still able to increase their regular dividend, and even made several special dividend distributions that rewarded their shareholders above their historical norms.

Hypothetical Dividend Growth Portfolio Review

Performance Prior, During and After the Great Recession

The following table illustrates several important attributes and benefits of how this quality dividend growth stock portfolio comprised of Dividend Champions or Aristocrats performed through the Great Recession of 2008. The first column shows the capital appreciation/depreciation effects of stock price volatility.  Here we discover that capital depreciation of just under $25,000 (24%) in 2008 represented a lack of liquidity more than a loss.

As long as the investor did not panic and turn an unrealized loss into a realized loss, there was no permanent damage to their net worth. But more importantly, we see from the Dividend Income column that their cash flow increased from $2,313 in 2007 to $2,530 in 2008. Accomplished dividend growth investors primarily focused on their income, were happy to receive a raise in pay during the throes of the Great Recession.

What is really interesting about this portfolio is how quickly it recovered from the losses of 2008.  By year-end 2009, the portfolio’s value had recovered to its previous high valuation, and capital appreciation and the growing dividend income stream both continued their strong ascent thereafter.

Hypothetical Portfolio Performance, Capital Appreciation & Dividend Income 2007-2012

The Angel is in the Details

At this point, I would like to turn to the F.A.S.T. Graphs™, fundamentals analyzer software tool, in order to illustrate how benign a recession, even a doozy like we had in 2008, can really be longer term. I would utilize the specific examples of the 10 companies in my portfolio to alter the adage “the devil is in