The Rising Dividend Strategy

DCM's Cornerstone investment style focuses on financially strong companies, with dividend yields higher than the average for the S&P 500, who are consistently and significantly growing their dividends.

One of the reasons the stock markets lost their way in the late 1990s and early 2000s was because valuing companies solely on the basis of earnings proved to be unreliable. Valuing stocks on the basis of dividends, however, is very similar to valuing a bond, which is intuitive and a function of reasonably simple math. The Cornerstone approach makes good sense, has a long track record of success, and has a quantifiable nature that roots it in common sense.

The companies we own in Cornerstone have such long records of consistently increasing their dividends that, by using regression analysis, we can estimate with a high degree of confidence what their dividend will be five or ten years from now. This cannot be done for all stocks, but we can do it for companies that raise their dividends consistently year after year.

Let's look at one example of a Rising Dividend company.

Abbott Labs (ABT), headquartered in Abbott Park, Illinois, operates four business segments: pharmaceutical products, diagnostic products, nutritional products and vascular products. They have increased their dividend every year for 35 years in a row. Not just paid a dividend for 35 years – but increased it every year. To increase its dividend year after year, a company has to increase its earnings at a steady pace. This also means their business must be repeatable, sustainable, and consistent. Pharmaceutical companies are only one of several industries that exhibit these characteristics.

A close examination of our Cornerstone portfolio would show that these companies are in industries that have economic "moats" surrounding their businesses. They are not necessarily monopolies, but their businesses are insulated from competition and environmental factors by regulations, high barriers to entry, or extremely consistent demand for the goods and services they offer.

As shown in the graph above, companies like ABT have also demonstrated a commitment to their shareholders through a dividend that is growing with their business. ABT's dividend (shown in blue and measured on the righthand axis) has increased consistently nearly 12% each year over the past 20 years. Not many companies can maintain this kind of growth, but many good companies do continue to increase their dividends each and every year. Can we have any assurances that the assumptions we make about future dividend growth are reasonable? Based upon our studies, we think so. First, note that ABT's dividends continued to increase throughout the nineties and through the worst bear market in over sixty years, 2000 thru 2002.

It may seem like backward thinking to suggest that ABT's price (shown in red) is in large part a function of its dividend yield. That is like saying that the price adjusts to keep the dividend yield within certain limits. Conventional thinking says the price moves in its own world and the dividend yield simply falls wherever it may. We believe, however, when it comes to Rising Dividend stocks, the dividend increases do, in fact, push the stock price higher. And, predicting dividends is far more reliable than predicting earnings per share, price-earnings ratios, or other measure upon which popular investing relies.

Statistically, we see stocks with rising dividends consistently show price growth that is highly correlated to dividend growth. Not necessarily on a quarter-by-quarter basis, or even on an annual basis, but in the long run, we cannot find a consistent dividend-paying company where price and dividend growth do not move together.

A great explanation for why this happens lies in the dividend yield (the dividend ÷ the price). As the table above shows, at the end of 1989 one share of ABT sold for $8.50. It paid a dividend of $0.18 per share. That gave ABT a yield of 2.12% (0.18 ÷ 8.50). Over the next twenty years, ABT's dividend rose, on average, 11.54% each year. Had the price remained at 8.50 over that time, the dividend yield by 2009 would have been 18.82%. Of course, the yield never got that high.

Why? Because an 18.82% yield for ABT, a financially strong company, would become unbelievably attractive. Every investor with half a mind would have rushed in to buy ABT. That would have driven its price up, causing the yield to fall until it was no longer "unbelievably attractive." In fact, that is exactly what happened, it just didn't happen all at once. It happened in little steps, over and over. As ABT's Board of Directors raised the dividend every year, their stock became valuable, and investors responded over time by willingly paying more for the stock. Our research says that, statistically and mathematically, consistently increasing dividends will ultimately drive share price higher.

Our job at DCM is to make sure that the best of the companies with increasing dividends are in our Rising Dividend portfolios. We do sell these companies from time to time. When something genuinely threatens a company's ability to increase its dividend, we replace it with a company in which we have more confidence of continuing dividend growth. We also sell comapnies whose stock prices get pushed to levels much higher than their dividend and dividend growth rates would indicate they are worth.This focus on dividends keeps us and our clients out of the guessing game about which companies will beat their next quarterly earnings projection.

Since its inception, Cornerstone has produced average, annual compounded returns (net of fees) better than the S&P 500, and that has been done with far less volatility.