What to Look For in a Sustainable Dividend Grower

It is easier for a company to simply pay a dividend than it is for them to grow it consistently. In this episode, we look at four factors that are regularly characteristic of sustainable dividend growers.

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Transcript

Greg Denewiler  0:05  

Hello, this is Greg Denewiler and you're listening to another episode of the dividend mailbox, a podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks and make each year's check larger than the last.

Greg Denewiler  0:26  

Last episode, we looked at why buying a growth dividend, even though it usually starts at a much lower yield, will most likely over several decades create a much greater return. In today's episode, we're going to look at what are some of the characteristics that are common with companies that grow their dividends consistently. 

Greg Denewiler  0:50  

So, one of the first characteristics that we are going to look at is the moat or competitive advantage. And here, think about the old castle where you have the water around the castle. The theory goes is that it was easier to defend. The moat of a company is sort of the same concept. A lot of times there are brands that have been built over decades, and it's very hard for another company to come in and spend the money to create the same brand awareness to compete. There are several different ways a company can have a competitive advantage, they can be a low-cost producer, they can have technology, they can be a dominant player in a market niche. There are multiple different competitive advantages. However, the point is, you want something that makes it harder to compete against. It helps drive the long-term earnings growth, which translates into dividend growth if it's a dividend payer. 

Greg Denewiler  1:58  

The second concept that we're going to look at is financial engineering. This is a big one, because especially in this environment where you have such low interest rates, companies are putting on debt. Now, one way you can look at debt is it's an asset, if you have, say, you can borrow money for 30 years at 2.5%. Well, we may never see that again. So, locking it in now, you know, it's an asset. Well, one of the problems with debt that you have to be careful with is it is a fixed liability. So, in a recession, if the company is somewhat cyclical or their earnings are not as predictable, it doesn't matter what the cost of debt is, in a time of stress it can be too much. So, as a general rule, what we like to look for are companies that have debt that are less than 100% of their equity. Meaning if they have a dollars’ worth of assets, they don't have more than a dollars’ worth of debt. Now, you can't overgeneralize because some companies that have stronger moats- stronger brands can put more debt on because there are more predictable. But one of the big things that is a big red flag is you want to really be careful with companies that are growing debt over time and they're using that debt to buy back stock and also to raise the dividend. There, you get into a situation where at some point, it's not sustainable. The whole point of buying long term dividend growth is you want a dividend that's sustainable. 

Greg Denewiler  3:46  

The third thing that we will look at is just steady profit margins. You know, again, this does come back somewhat to the moat or competitive advantage, but you want companies that have consistent profit margin where they're able to get a decent return on their on their assets. and then they can reinvest. They can buy capital, pay out a dividend, and grow that dividend over time. 

Greg Denewiler  4:16  

The fourth thing that we'll look at, and this is another big one, is companies that go out and acquire other companies. Numerous studies show that most of the time when a company acquires another company, they just don't go as well as what management projects. Virtually every time, the projections are "we're going to save all this money", or "we're going to expand our product line with the current company", or "we're going to save money by selling off assets". But again, study after study shows, most of the time, these things do not work out as well as they're supposed to. And what that leads to is a company that puts on more debt. And because they're paying a big premium for the company, they issue more equity, and it dilutes the existing shareholders. So, in that case, it puts stress over time on a company's balance sheet. Then the company has to focus on getting the balance sheet where they were before and they're not able to focus as much on the dividend. So, those are four things that- just ideas that what you're looking for growing dividends. It's the moat/competitive advantage, looking at debt (which is financial engineering), profit margins (you want to look at a somewhat consistent profit margin). And also, if a company is out acquiring other businesses and just trying to create an empire, as opposed to consistent earnings growth. 

Greg Denewiler  6:08  

Now, one thing to remember is, you know, a lot of I think a lot of investors these days, and especially younger investors, they look at a dividend stock and they think it's just a boring company. But the reality is, these boring companies that pay dividends that grow them by 5, 6, 10% a year consistently over a decade, by the very definition of that dividend growth, they have to be growth stocks. So, just keep that in mind as you look at allocating money towards a dividend growth portfolio. For the next episode, we're going to look at some of the long-term successful companies that have been dividend payers. I think what you're going to find- you're going to be very surprised when you look at some of these names. And you're going to look at the return that has come from the stock price and then you're going to see where when you add in the dividend that was paid over that same time period, the rates of return went up fairly dramatically. It's going to be eye opening to see just how impactful these dividends can be. 

Greg Denewiler  7:24  

If you liked today's podcast, please leave us a review and follow us on LinkedIn, Instagram and Facebook. If you would like more information regarding dividend growth or just our style of investing, go to grow my dollar.com. There you will find some of our previous podcasts and also our monthly newsletter. Past performance does not guarantee future results. Each investor should consider whether a strategy is right for them and consider all the risks involved. Dividend Stocks are volatile and can lose money.