Dividend growth investors tend to view investing differently than those seeking returns primarily through a higher share price. Those investing for income tend to value a growing, safe dividend as much or more than a higher share price. For these investors, creating a portfolio that can provide capital to cover expenses in retirement, dividend safety is of the upmost importance.
We believe that the best place to find stocks that meet this requirement is in the Dividend Aristocrats index.
Benefits of the Dividend Aristocrats
To gain entry into this index, a company must be a member of the S&P 500, have at least 25 consecutive years of dividend growth and have a certain market capitalization. There are just 65 stocks currently in the Dividend Aristocrat, illustrating how exclusive membership truly is.
Beyond a lengthy track record of dividend growth, the Dividend Aristocrats usually have several important characteristics.
Paying a dividend represents a commitment to distributing capital to shareholders on a regular basis. This capital needs to be covered, otherwise a company would have to take on debt to maintain its payments. Doing so would adversely affect the balance sheet, which is a major reason why companies in this position often reduce or eliminate dividends as opposed to increasing debt obligations.
Another important characteristic of Dividend Aristocrats is that they, as a group, tend to produce higher returns with lower volatility. Wild swings in share price up or down are often less frequent, especially for blue chip companies as revenue and earnings tend to be more consistent than high growth names.
Lower volatility is generally a benefit to investors investing for income as quarterly cash dividend payments allow for some portfolio predictability. This can also provide market beating returns, even when the market is performing very well. Take for example, the month of March. The S&P 500 index expanded 4.5% for the month, an impressive one-month total return. Compared to the 7.6% return for Dividend Aristocrats ETF (NOBL), however, that return starts to look less impressive.
Expanding our view to the last 10 years, this trend continues as well. The Dividend Aristocrats have compounded annual returns at a rate of 14.2% per year over the last decade while the S&P 500 index is higher by 13.9%.
In addition, Dividend Aristocrats have proven that their business models work over a long period of time. Companies struggling to grow through all portions of the economic cycle can face severe hardships that make paying a dividend a luxury that can’t be afford.
Dividend Aristocrats tend to have products or services that are in demand in times of both economic expansion and contraction. Consistent growth can result in very healthy dividend payout ratios, one of the reasons that these companies can continue to increase dividends even as business results may struggle at times.
As a result, the Dividend Aristocrats tend to hold up much better during a recession. The last recession spared very few companies, the Dividend Aristocrats included. The Dividend Aristocrats index declined 22% from 2007 to 2008, a sizeable one year draw down. At the same time, the S&P 500 index lost 38%, nearly double that of the Dividend Aristocrats. It is during periods of economic difficulty that the strength of the Dividend Aristocrats really shows. The demand for products and services allows for continue dividend growth which attracts investors and helps to mitigate losses. The dividend yields also help to offset declines in the share price.
Not only do the Dividend Aristocrats tend to see less of a loss during a recession, but they also outperform the S&P 500 over long periods of time. For these reasons, we believe income investors should consider making members of the Dividend Aristocrats the backbone of their retirement portfolios.
An Example of a High-Quality Dividend Aristocrat
All of the Dividend Aristocrats have impressive dividend growth streaks, but not all Dividend Aristocrats are attractively valued right now. There are some, however, that look like a compelling buy based on their attractive valuations, in addition to their dividends. One example is AbbVie (ABBV).
AbbVie was formed when its parent company Abbott Laboratories (ABT) spun off its biotech business in 2013. Including the years it was a member of its parent company, AbbVie has increased its dividend for 49 consecutive years. On its own, the company has raised its dividend for the past nine years.
Humira has largely been responsible for much of the gains in the share price, but this product is facing patent cliffs. This one product provided AbbVie the ability to grow its dividend with a compound annual growth rate of more than 23% since 2013. Even with such a high rate of growth, the earnings-per-share payout ratio is projected to be just 42% in 2021.
The company does expect revenue for Humira, which was one of the best-selling drugs over the past decade, to decrease going forward, but we feel AbbVie is well positioned with respect to the rest of its pipeline. Therefore, we believe its future dividend growth is likely assured.
Rinvoq, treatment for moderate and severe rheumatoid arthritis, Skyrizi, which treats psoriasis, and Venclexta, used for treatment in patients with relapsed leukemia, all are expected to see double-digit growth in the coming years. Peak sales for newer products are projected to nearly replace those lost from Humira. AbbVie also added Allergan recently, which has contributed to the company’s bottom-line.
Despite the positives going for it, AbbVie trades with a multiple of 9.2 times analysts’ estimates for 2021. We feel that the market is penalizing the company too much for Humira declines and not taking into consideration AbbVie’s pipeline. We feel a 2026 price-to-earnings ratio of 10 times earnings is fair value. Valuation could therefore add 1.7% to total annual returns over the next five years. Combined with an expected earnings growth rate of 3% and dividend yield of 4.6%, AbbVie shareholders could be looking at a total return of 9.3% through 2026.
Solid business prospects, low valuation and a high dividend yield are why we feel that AbbVie can generate strong returns at the current price.
Final Thoughts
Dividend paying stocks have a lot of features that should appeal to income investors. Companies which count their growths streaks in decades usually have very stable business models that provide for dividend increases. This strength also allows for a better performance during recessions and higher annual returns over long periods of time.
To us, investors looking for stable, growing and protected dividends should strongly consider the Dividend Aristocrats index.
Leave a Reply