A History Of Rising Dividends: Attributes Of A Good Dividend Stock

2008 May 8

by Kyle

from → Investing And Investments, Passive Income

Welcome to part II of my series examining the attributes of good dividend stocks. The first thing to look for when analyzing a dividend stock is its dividend history. A long record of rising dividend payments shows discipline, sensible capital allocation, and demonstrates management’s commitment to shareholders.

Earnings You Can Take To The Bank

You might not be aware of this, but *gasp* companies sometimes bend the truth when it comes to earnings. It would be nice if you could trust management to tell the truth, the whole truth, and nothing but the truth but alas, it is not to be. From Waste Management to Enron to Worldcom, Wall Street has a long history of accounting scandals. Sometimes, companies can get away with cooking the books for years before being caught but when it finally comes time to pay the piper, usually it’s innocent shareholders who get stuck holding the bag (just ask anybody owning Enron stock).

Unlike earnings, which can show pretty much anything the accountants want them to show, dividends are real cash payments to shareholders. Cash can’t be faked, manipulated, or lied about. If the dividend history jives with the earnings history over long periods of time, you can be reasonably certain those earnings were real and not the resort of accounting gimmickery (after making sure the company wasn’t simply borrowing money to pay those dividends, of course). If dividends rose 8% per year while earnings rose 20% per year over the last decade, on the other hand, it should immediately raise a red flag in your mind. Why didn’t management raise the dividend more or less in line with earnings? Perhaps they couldn’t because those earnings were only on paper. Of course, there are plenty of legitimate reasons this might happen, but unusual dividend policy is often a good early sign of trouble.

Dividends Show Management’s Commitment To Shareholders

Steadily rising dividends show management’s commitment to shareholders in a way few other actions can. Since the management of larger companies tend to be better-compensated than management of smaller companies, company executives have a powerful incentive to grow the company at all costs, even if such growth isn’t in the best interest of outside shareholders. By paying out excess earnings as dividends to shareholders instead of retaining it to be foolishly squandered on ill-advised expansion projects to serve insider interests, management shows a willingness to reward shareholders even if it might not serve to maximize executive pay. This is exactly the sort of manager you want running your company. A good manager knows when to expand and when to return capital to shareholders.

The Mergent Dividend Achievers Index

The Mergent Dividend Achievers Select Index tracks the performance of dividend paying stocks with a record of increasing their regular annual dividend at least 10 years of consecutive and is an excellent starting point when looking for potential dividend stocks. Its constituents run the gamut from mega-cap consumer staples and financial companies to small-cap manufacturing concerns. One could easily construct a diversified portfolio based on this index. Alternately, you could just buy the new Vanguard Dividend Appreciation Index Fund (VDAIX) or its ETF version (VIG), which holds the entire index.

Attributes Of A Good Dividend Stock

Please read the rest of the series