What is a Perpetual Dividend Raiser?

WHAT IS A PERPETUAL DIVIDEND RAISER?

When I first got into the financial industry, I was an assistant on a trading desk, eventually working my way up to trader. Before I knew how to analyze a company by reading balance sheets and income statements, I learned about stock charts. Two key concepts in reading stock charts are:

• The trend is your friend.
• A trend in motion stays in motion.

Essentially, what these two concepts mean is that a stock will continue moving in the same direction until it doesn’t any more. How’s that for insight?

But when you look at a chart of a stock that is heading higher, although there are some minor corrections, it often moves on a diagonal line (called a trend line) upward. Stocks traveling along one of these trend lines usually continue until something changes their direction. The cause of the change of direction could be a bad earnings report, weak economic data, or a large institution selling its shares. Frequently, once the trend is broken, the stock will reverse.

Investors who trade using chart data look for opportunities to buy shares of stocks that are trending higher. I bring this up because the same can be said about companies that raise their dividends.

Typically, a company with an established trend of increasing their dividends will raise them again next year and the year after that and the year after that . . . unless it becomes impossible to do so. Management knows that investors have come to expect the dividend boost every year and any change in that policy will send them running for the exits.

I call these companies Perpetual Dividend Raisers, and they come in more than one variety.

Dividend Aristocrats

The concept of a Dividend Aristocrat is simple. A Dividend Aristocrat is a company that is a member of the S&P 500 index and has raised its dividend every year for at least 25 years.

These are primarily blue chip companies with long histories of growing earnings and dividends.

If your investing goals are to impress your friends at cocktail parties with your knowledge of brand-new technology and to brag about the millions of dollars you will make off of the companies behind those technologies—well, then, Dividend Aristocrats aren’t for you.

Most people don’t find a company like Genuine Parts (NYSE: GPC), which makes auto replacement parts, to be terribly exciting. I’m not even sure Genuine Parts’ CEO is all that excited about replacement parts.

But the company makes a ton of money—$565 million in 2011—and it has increased its dividend every year since 1956. That is pretty exciting.

Think about that for a minute: Every year. Since 1956.

Through the Cuban Missile Crisis, the Kennedy assassinations, Vietnam, Watergate, gas lines, the Cold War, the rise of Japan, the rise of China, 9/11, the dot-com collapse, the housing bust, and the Great Recession—through all of these difficult, and in some cases tragic, events, when pundits were saying the sky was falling, at times when the economy really did stink, Genuine Parts went about its business, making and selling auto parts and returning more money to shareholders than it did the year before.

The last time Genuine Parts did not increase its dividend, President Eisenhower was in the White House and Elvis Presley made his television debut on The Louisiana Hayride on KSLA-TV in Shreveport, Louisiana.

That was a long time ago.

And that is pretty darn exciting.

The Index

The Dividend Aristocrat Index is currently made up of 51 companies and is rebalanced every year. If a company raises its dividend for the twenty-fifth consecutive year, it is added to the index the following December. If a company fails to raise its dividend, it is removed.

In order to qualify to be an S&P Dividend Aristocrat, a stock must meet these four criteria:

• Be a member of the S&P 500 index
• Have increased its dividend every year for at least 25 years in a row
• Have a market capitalization of at least $3 billion on the day the index is rebalanced
• Trade a daily average of at least $5 million worth of stock for the six months prior to the rebalancing date

In 2012, ten companies, including Nucor (NYSE: NUE), were added to the index, while one company, CenturyLink (NYSE: CTL), was dropped.

Each company is given equal weight in the index. This means that the size of the company isn’t a factor in the calculation of the performance of the index. A company with a $20 billion market cap has the same impact on the index as a $40 billion company.

Some other variables can impact a company’s ability to be placed in the index, such as sector diversification. But these other considerations don’t come into play often. The most important factors are 25 years of consecutive dividend increases and being a member of the S&P 500.

The index is great for showing you all kinds of performance statistics as to why Dividend Aristocrats make excellent investments and how they outperform the S&P 500. But you can’t buy the index. Surprisingly, there isn’t an exchange-traded fund (ETF) or mutual fund that tracks the S&P 500 Dividend Aristocrat index.

ETF: A fund that is bought and sold like a stock. It often tracks an index or sector and is passively managed—meaning an investment manager is not actively making buying and selling decisions based on the economy, market, or a company's prospects. Stocks in an ETF are bought and sold based on their inclusion or weighting in an index or sector.

There is, however, an ETF that is based on the S&P High Yield Dividend Aristocrats index. This index is made up of the 60 highest-yielding members of the S&P Composite 1500 that have raised their dividends for 25 years in a row.

This ETF is called the Standard & Poor’s depositary receipt (SPDR) S&P Dividend ETF (Amex: SDY). It attempts to track the performance of the S&P High Yield Dividend Aristocrats Index.

And while it might be tempting to buy the SPDR S&P Dividend ETF for convenience purposes, I do not recommend buying or owning it for several reasons.

• You have no control over the sector weightings. For example, as I write this, 24% of the portfolio is invested in utilities. That is not particularly surprising, as utilities are often the highest- yielding stocks. But you should have more control over your own portfolio and invest according to the way you see fit.
• It lacks a track record. The SPDR Dividend ETF has been around only since 2007. Aristocrats have at least a 25-year track record. Achievers, which we’ll discuss later, have at least a ten-year track record. The purpose of investing, according to the ideas laid out in this book, is to put your money in stocks with a long history of rewarding shareholders by increasing the dividend. As it turns out, the SPDR Dividend ETF lowered its dividend in 2009.
• In many cases, we can find higher yields in individual stocks rather than this ETF.

There are no mutual funds dedicated to Dividend Aristocrats at this time.

The Champions

Dividend Aristocrats represent the bluest of the blue chips—big, solid companies with two and a half decades or more track records of raising dividends.

However, with only 40 to 50 stocks qualifying to be included in the index in a given year, we need to expand our universe— especially because not every Aristocrat has a decent yield. Just because a company has raised its dividend for 25 years in a row doesn’t mean it has an attractive dividend yield.

The yield could have started very small and grown at a minuscule pace. Or the stock could have gotten hot, running up in price and decreasing the yield. For example, Aristocrat Sherwin-Williams (NYSE: SHW) has raised its dividend for 33 consecutive years but still only yields 1.5%.

Therefore, we need to look in other places for companies with juicy yields that have a history of growing the dividend.

Enter the Champions.

The DRiP Resource Center. These stocks are similar to the Aristocrats in that the companies have raised their dividends for at least 25 consecutive years. However, they are not required to be part of the S&P 500 and have no liquidity or other restrictions. Just the 25-year track record with an annual dividend boost. That’s the only qualification.

I love the name Champions because it reminds me of my favorite sport, boxing, and that a person doesn’t need to be six foot three and 240 pounds to be a successful professional athlete.

I’ve seen grown men who weigh 125 pounds walk into an arena and be given the same respect (or even more) by an adoring crowd as if they were the heavyweight champion of the world.

Some of the small stocks on the Champions list also prove you don’t have to be big to be successful, More than a few have market caps of under $1 billion yet are still terrific income investments.

For example, Tompkins Financial Corp. (NYSE: TMP) is a Dividend Champion. Tompkins, a small bank based in Ithaca, New York, has a market cap of just $451 million and trades an average of 25,000 shares per day. Compare that with an Aristocrat such Kimberly Clark (NYSE: KMB), which has a market cap of $29 billion and trades 2.5 million shares a day.

As we look at Table 2.1, the list of Champions includes—but is not limited to—Dividend Aristocrats. Typically, the Champions list has more than twice the number of stocks as the Aristocrats.

Dividend Aristocrats are always Dividend Champions because they’ve raised their dividend for 25 years in a row but a Dividend Champion might not be a Dividend Aristocrat if the stock is not in the S&P 500.

Some of the stocks on the Champions list offer benefits to individual investors that may not be attainable by professional money managers.

Table 2.1 Perpetual Dividend Raisers        

Some Champions are rather small, so an institutional investor, such as a mutual fund manager, would not be able to buy stock without moving the price considerably. Additionally, the manager might have a tough time selling the stock due to liquidity issues.

For example, if a mutual fund manager wanted to own a few million shares of California Water Service Group (NYSE: CWT), it would be tough to either accumulate or sell stock when the time comes, considering that it trades fewer than 250,000 shares per day.

However, an individual investor who wants to pick up several thousand shares or fewer would have no problem buying or selling them in the marketplace. In this case, the individual investor has more flexibility than the money manager with millions at his or her disposal.

The professional money manager can invest only in stocks that are large enough to handle the influx of money and must buy enough shares to make a difference to the fund’s performance. The individual investor can buy or sell without impacting the stock or attracting much notice. The ability to purchase stocks that are inaccessible to professionals is one way individual shareholders can outperform institutional money managers.

As you conduct your research on Perpetual Dividend Raisers, you’ll find plenty of stocks that don’t trade much volume but are great little companies with long histories of dividend increases. You’ll be able to buy them, but the fund manager at Fidelity and Vanguard will have to pass them up.

Junior Aristocrats

There are usually only about 40 to 50 Dividend Aristocrats and about 100 Champions.

Although 100 stocks sounds like a lot, keep in mind that, like the Aristocrats, not all of them have attractive yields. Despite annual raises, many still have yields below 3%. So we need to expand our choices even further.

The next groups of stocks are the Dividend Achievers and Contenders.

Dividend Achievers are stocks that have raised their dividends for ten or more consecutive years and meet very easy liquidity requirements.

Moody’s Investor Services started the list in 1979, and it is now maintained by Indxis.

Interestingly, although no ETFs track the Dividend Aristocrats, several follow Dividend Achievers.

The Vanguard Dividend Appreciation ETF (NYSE: VIG) tracks the Mergent Dividend Achievers Index. (Mergent is owned by Indxis and maintains the index.)

The Powershares Dividend Achievers (NYSE: PFM) tracks the Broad Dividend Achievers Index. An important difference between the Dividend Achievers Index and the Broad Dividend Achievers Index is that the Broad Index can include Real Estate Investment Trusts (REITs) and Master Limited Partnerships (MLPs). Those stocks often have higher yields. We’ll discuss REITs and MLPs in Chapter 6.

The Powershares High Yield Equity Dividend Achievers (NYSE: PEY) corresponds to the Mergent Dividend Achievers 50 Index. The Achievers 50 Index consists of the top 50 highest-yielding stocks in the Broad Dividend Achievers Index that have raised their dividends for at least ten straight years. These stocks also must trade a minimum of $500,000 worth of stock per day in the November and December prior to reconstituting the index.

Just as Achievers are like junior Aristocrats, Dividend Contenders are like junior Champions.

The Aristocrats and Achievers lists are maintained by two institutional financial firms: Standard & Poor’s and Indxis. Both lists are reconstituted once per year. The Champions and Contenders list is maintained and dutifully updated every month by David Fish of the DRiP Resource Center.

The only thing a company has to do to qualify to be a Contender is raise its dividend every year for 10 to 24 years. Similar to the Champions, there are no liquidity or index requirements.

And just as all Aristocrats are Champions but not all Champions are Aristocrats, all Achievers are Contenders but not all Contenders are Achievers.

Champions and Contenders have the same time requirements as far as number of years of consecutive dividend raises as Aristocrats and Achievers, but the Champions and Contenders have no other restrictions.

Beneath the Contenders are the Challengers. These are companies that have raised their dividends between five and nine years in a row. Challengers are also part of the compilation tracked by David Fish and the DRiP Resource Center. As you can see in Table 2.1 Champions and Contenders have the same requirements.

You might automatically think that you should stick with Champions because of their long-term track record. After all, with a 25-year (or more) history of boosting the dividend, the company is probably more likely to continue to raise the dividend than one with just a 5-year record.

Typically, fewer than 10% of Champions fail to raise the dividend in any given year, while roughly 15% of Contenders and Challengers do not boost the dividend.

However, it’s important to understand that because Champions are either more mature or have more mature dividend programs, their yields and dividend growth rates are often lower than those of Contenders.

For example, as of the end of 2011, the average yield for a Champion was 2.94% versus 3.1% for a Contender and 3.36% for a Challenger. The most recent average dividend increases were 7.24%, 8.47%, and 10.99% respectively. The current growth rates are lower than their average ten-year growth rates as companies are undoubtedly still smarting from the recession. (See Table 2.2.)

The difference seems small but gets magnified as the years go on.

As you can see from Table 2.2, if you invest in the average Champion, and each year the dividend grows by the same amount as in 2011, after ten years your dividend yield would be 5.5%.

Table 2.2 Champions, Contenders, and Challengers

In the case of the Contender, your yield would increase to 6.4%. If your original investment was $10,000, based on the given assumptions, in ten years you’d collect $4,592 in income with the Contender and $4,108 from the Champion.

The Challengers, with their much higher dividend growth rates, blow away their more mature peers. After ten years, the dividend yield surges to 8.6%, and the investor would have collected $5,615 in income.

As with most investments on Wall Street, the seemingly safer investment typically offers a lower yield and growth prospects—in this particular situation, I’m talking about dividend growth, but often, share price growth is less for safer companies than those with more risk.

Investors have to weigh their need for safety against their need for income or growth. A Dividend Contender/Achiever can still be a relatively safe stock. A company like Atmos Energy (NYSE: ATO), a Dallas-based natural gas distribution and transportation company, has boosted its dividend every year for 23 years. Since 1988, the stock has risen at a compound annual growth rate of 5.4% (not including dividends).

In the Challenger category, a company such as Columbia Sportswear (Nasdaq: COLM) has raised its dividend every year for six years. During that time, the stock has risen 68%, or a compound annual growth rate of 9% per year.

Challengers, being earlier into their dividend-raising histories, tend to lift their dividends at a faster pace than Champions and Contenders. (See Table 2.3.)

Table 2.3 Annual Dividend Growth Rates as of December 2011

Survivorship

From the statistics just cited, you might automatically think that investing in the Challengers is the better way to go. After all, they offer a higher yield and higher dividend growth rate. Besides, for the most recent dividend increases, their one-, three-, five-, and ten-year dividend growth rates are higher as well.

However, you need to take into account survivorship—the fact that the companies we are examining are the ones that did not get dropped from the list of Challengers. In other words, there are some companies that you may have invested in years ago, expecting a never-ending increase in the dividend, that were cut because they failed to raise the dividend.

For example, up until February 2009, financial services firm F.N.B. Corp. (NYSE: FNB) had a 35-year history of raising its dividend. In the ten years prior, the company grew its dividend by an average of 7.8% per year.

However, in August 2008, after 35 straight years of dividend boosts, the company kept its $0.24 quarterly dividend the same as it was in the previous year and in February 2009 cut the dividend in half, where it remains today.

So F.N.B is no longer calculated in any growth rate or total return figures pertaining to Dividend Champions.

Later in the book, I’ll show you that the odds are in your favor that your company will continue to raise the dividend each and every year especially after you learn what to look for in a stock to ensure the safety of the dividend.

SUMMARY

• Dividend Aristocrats are members of the S&P 500 that have raised their dividends every year for at least 25 years.
• Dividend Champions are any stocks that have raised their dividends for 25 consecutive years.
• Junior Aristocrats include companies that have raised their dividends between 5 and 24 years in a row.
• You’re better off buying individual stocks rather than dividend ETFs or funds.
• Genuine Parts’ CEO falls asleep at his desk because his business is so boring. (Okay, he probably doesn’t. But no one would blame him if he did.)