Dividend Growth Investing
Following on from my last post on the 5 reasons I prefer investing in the US over MY, I’d like to dive deeper into one of the reasons I have presented – “(4) Dividend Investing is actually a thing”.
This is also the reason that kickstarted my Freedom Portfolio that is aimed to build a long term sustainable passive income – you can check out my tracker here.
This is boring investing. So don’t expect any excitement to come out of this.
But it can be rewarding.
Dividend as a source of passive income
As mentioned in one of my earliest posts, passive income can come from 4 main sources:
- Interest
- Dividend
- Rental
- Royalties
Dividends come from investing in companies that take part of their profits to reward shareholders as cash payment.
The thing about dividends is that it will reduce the share price of the shares. This means that it will reduce our “capital gains on paper” in exchange for cash now.
I have written extensively about dividends here. It will good to understand how dividend works before we continue forward.
Case Study for Dividend Growth
Dividend growth is the phenomenon where the company increases its dividend quantum yearly.
Yes, you read it correctly. Think of it as a yearly increment to your passive income.
Consider this company which I am watching closely: 3M Company (MMM) – $200.30 as at 13 Aug 2021
Extracted from SeekingAlpha.com:
2 important points I want to highlight from this:
- It has consistently increased its dividend for the last 62 years; and
- The yearly increment is 6.7% on average for the last 5 years
Now take a look at this (also extracted from SeekingAlpha.com):
Assuming we invested in MMM in 2016 at $180 per share. The price has increased only about 11% from 5 years ago.
As for its dividends…
The 5 year dividend history shows:
| Year | Dividend Amount | Yield (based on $180) | Increased |
|---|---|---|---|
| FY2016 | $4.44 | 2.5% | – |
| FY2017 | $4.70 | 2.6% | 6% |
| FY2018 | $5.44 | 3.0% | 16% |
| FY2019 | $5.76 | 3.2% | 6% |
| FY2020 | $5.88 | 3.3% | 2% |
Total dividends collected over 5 years (per share) = $26.22
This translates to 14.6% of the $180 that we initially invested.
If we invested in MMM 10 years ago instead at the price of only $80:
- The FY2020 dividend of $5.88 represents a yield of 7.4%
- Capital gains of 1.5x = Profit $120.30
- Total 10 years dividend collected = $40.84 (51% total returns)
Perhaps you’re thinking… the returns are not significant. Let me show you another angle of looking at this…
Building a legacy machine
Imagine you started with a portfolio of $100k and you’re fully invested with an average dividend yield of 3% today.
That will generate $3k in year 1.
Assume a modest 3% (or 5%) yearly dividend growth rate for your portfolio, the yearly dividend that you will expect to get:
- Year 10 = $3.9k ($4.7k)
- Year 20 = $5.3k ($7.6k)
- Year 30 = $7.1k ($12.3k)
- Year 40 = $9.5k ($21.1k)
Bear in mind that we have not accounted for:
- Additional capital injected into this portfolio
- Higher dividend growth rate
- Capital gains from this portfolio
At year 40, you’re looking at 10% – 21% dividend yield!
The focus of this portfolio will be purely on income generation and not capital gains. So, maintenance will be very minimal. We just have to make sure that the company is still good fundamentally and there is no risk of dividend cuts. If you follow corporate america’s news, you will definitely catch wind of any potential dividend cuts (e.g. AT&T).
As I mentioned, dividend growth investing is a huge thing in the US stock market.
With this, you will have an income producing machine in your hands that will perpetually generate passive income for you and whoever you decided to pass this on.
The past does not represent its future
Whilst all these are based on the historical track record of the companies and definitely does not in any way represent that the future will continue this trend, it gives a pretty good idea.
Dividend growth trend – For a company that has been increasing dividends for 10 years, 20 years, up to 60 years, there is no reason to cut their dividends unless fundamentally the company is facing a crisis. Hence, it also becomes a sign of trouble brewing should any investee companies start cutting dividends.
Closing Thoughts
This investing strategy is a slow but sure way of accumulating a bunch of assets that will generate a passively increasing income for the future.
It may not even be substantial enough for you to live off of when you retire, unless the capital is sizeable.
However, this can be a generational income producing asset that will benefit for the next generations to come.
That’s why it’s better to start this as early as possible. That’s what my Freedom Fund is for – my retirement income & legacy machine.
A portfolio that I can park one side and generate income for me without much worry. Whilst I focus attention on my higher risk options trading to generate active investing income.
