Investing > Complete Guide to Dividend Growth Investing

Complete Guide to Dividend Growth Investing

Are you a fan of passive income? Here's how it works with growth dividends.

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Updated May 29, 2022

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Is there anything better than receiving income for doing hardly anything at all?

Well, even if there is something better, it probably isn’t the income you have to work for every month. Companies discovered this fundamental truth a long time ago, which is why they created dividends—the investor’s holy grail of passive income.

Basically, if you get enough dividend stocks, they give you a regular paycheck just for being their owner. That’s a pretty sweet deal, however, for this paycheck to be something more than glorified beer money, you need to have a bucket load of money invested—and that’s where growth dividends come in.

The logic behind it is: you find reliable companies that have hefty dividend yields, so you get the most bang for your buck. This sounds easy enough, right? Well, the reality is different—just ask those investing in dividend stocks before the COVID-19 pandemic who lost 12% of their dividend earnings in March 2020 as companies began to trim their dividend programs. This caused multiple stocks to plunge more than 85% overnight, costing investors millions. 

So, to avoid losing serious amounts of money on your quest for passive income, you must know how to find good stocks, what to do with them, and what pitfalls to avoid. Otherwise, you can fall into an expensive metaphorical pit like so many have. 

Because we like passive income very much, we wrote this in-depth guide. Here, we will discuss how this strategy works in detail, what kinds of stocks you should look for, and how profitable and risky dividends really are. So, without further delay, let’s dive in.

What you’ll learn
  • What is Dividend Growth Investing
  • How Does Dividend Growth Investing Works
  • Attributes of a Good Dividend Growth Stock
  • How Profitable is Dividend Growth Investing
  • The Dangers of Dividend Growth Investing
  • Dividend Growth vs. Value Investing
  • Dividend Growth Investing FAQs
  • Get Started with a Broker

Understanding Dividend Growth Investing 🧠

Before diving in, it’s important that you know exactly what dividend growth investing is. Dividend growth investing is an investment strategy where an investor will be involved in choosing and investing in stocks that have a high dividend return. This is usually done for the purposes of earning a passive income. 

Because dividend growth investing is seen by the public as more stable than other types of investments, as well as an easy way to make money, this type of investing attracts investors from every walk of life. You will often have people place their retirement savings, or other forms of life savings into dividend growth investing. 

How Does the Dividend Growth Investing Strategy Work? ⚙️

On paper, the investing strategy for dividend growth investing is easy, much easier than other comparable styles of growth investing. All you have to do is select stocks that pay their investors dividends, more specifically stocks that have been paying dividends for a long time, usually several years. 

But the strategy actually goes much deeper than this, as anyone who is interested in investing in dividend stocks also needs to consider several other aspects before they buy. And one of the things you should consider is the quality of the dividends given to investors over the years. For example, a company that has grown 7% annually for the past decade is much more favorable than a stock that has grown by 10% for two years followed by 1% for eight years.  

Dividend Process
Dividends provide stock owners with regular payments that ultimately depend on the board of directors’ decision.

Once the stocks have been selected and invested in, the dividends should begin to roll in. These dividends are yours to live off of, or spend as you please, but to truly embrace the dividend growth investment strategy, all returns earned should be reinvested into buying more shares of your high dividend yield stock. This will increase the number of dividends you earn next time around, and the cycle will continue. 

Thus, your portfolio should continue to grow over time—and this is why many people invest their retirement into dividend stocks. But if you are thinking that this sounds a bit too good to be true, that’s because it is, and despite common belief, there are several risks when it comes to dividend growth investing, more on this later. 

💡 Still confused about dividend yield? Learn about yield in stocks.

What Makes a Good Dividend Growth Stock?

If you want to be successful in dividend growth investing, then it is critical that you find the right company to invest in. And this actually goes far beyond selecting a company that offers high dividends over a long period of time. You’ll want to look into several other aspects of a company before you invest, some of them are listed below for your reference. 

Most people assume that companies will only issue dividends when they can afford to, but this simply isn’t the case, as many companies know that people are easily fooled by dividends. This leads to many deceptive practices by companies in order to keep the dividends high and the investments coming. This is why you must closely analyze any company you intend to invest in

Dividends Can Help You Beat Inflation 💸

You need to make sure that your dividend yields beat the rate of inflation. While a steady 2% return over a few decades sounds great, once you factor in inflation, say at a rate of 2.6%, you’ve actually made no money. 

This is why you will specifically need to search for stocks that issue dividends at a rate that is higher than inflation. This is very difficult, as inflation rates are constantly changing, and can spike without any notice. 

Take Chevron Corporation, which has historically boasted a 4.3% yield over the past three years leading to 2021. While this is quite impressive, and typically beats the inflation rate by a long run, reports issued in April 2021 stated that inflation is at 4.2%, meaning that a dividend stock that was once worth its weight in gold, now brings in a paltry sum that won’t satisfy even the most basic investors. 

US inflation rates by year
 The U.S. has almost always been in an inflationary environment since the early 1900s.

However, one more thing to keep in mind is that the price of the stock itself can grow. If a stock is growing faster than the pace of inflation, then your dividend payments can be considered pure profit—the ideal company has a solid dividend yield paired with good annual stock growth.

Companies Without Debt 💰

Sometimes, companies with debt will offer high dividends, because they want people to invest in order to boost their cash flow. But this is a problem because it means the company is depending on investments and sales, or increased debt, in order to pay these dividends. 

A scheme like this can fall apart if they don’t get enough investors, there are too many withdrawals at once, or their company doesn’t perform as predicted. Generally, you will want to look for companies with a 1:2 debt to equity ratio or lower. 

Companies With Cash on Hand 💵

You will also want to look for companies that have cash on hand. Because even if a company doesn’t have debt, this doesn’t mean that they have the ability to pay the high dividends that they may promise. 

They may be making these dividend promises off of current revenue, but if that revenue falls short, then they will either need to borrow money or sell more shares in order to pay your dividends—and neither of these is a good situation for your investment. 

A prime example of this is the aforementioned company Chevron, which was struggling to keep up with its 4.5% dividend yield in 2016. This led to the company borrowing money in order to keep its shareholders happy. But rather than helping the health of the company, this has only lowered it, leading many to think that it is on borrowed time, and will go under eventually. 

CVX lost
CVX lost a lot of revenue in 2015 due to the crash in oil prices. This led to the borrowing for dividend payments in 2016. Image by TradingView.

Companies With Long Term Growth Expectations 🌱

Above all else, you need to look for a company that you think will continue to grow. Just because a company has performed well over the past ten years, doesn’t mean that it will continue to grow in the next ten. This is especially true as technology advances and puts companies that used to be a favorite of dividend investors out of business.

For example, look at JC Penney, a stock that offered its investors a decent dividend of 3% or more for years until 2001 when the company began to decline thanks to the advent of online shopping and fast fashion. 

Still, it continued to offer a dividend to investors, even though its stock entered a downturn that it proved unable to recover from. The company didn’t stop giving its investors dividends until 2012, which at that point, it had become clear that the company would never recover, and its stock prices continued to fall until the company wasn’t worth more than pennies. 

But between 2001 and 2012, JC Penney still offered its investors dividends of at least 2%, frequently more, meaning they would meet the requirement of issuing dividends that beat inflation, although the company was clearly on its way out. 

Is Dividend Growth Investing Profitable? 💲

It can be easy to look at the dividend yield a company is promising and imagine yourself rolling in all that cash. But before you start counting your profits, it’s important to remember that the government still has to get their cut, and unfortunately, they demand a large cut of your dividend income. 

Dividend income is considered by the IRS to be income, which means you will pay taxes up to 20% of your dividends depending on your income. This is in stark contrast to the taxes you will pay on capital gains, which can be as low as 0% if you hold your stocks for more than a year. Because of this factor alone, it is often more profitable to buy stocks without dividends and hold them for a long time instead of focusing on purchasing stocks that offer dividends. 

Reasons to Invest in Dividend Growth 💱

Don’t let the paragraph above scare you, although you should be concerned about the taxes that come with dividend growth investing, there are still several reasons to invest. And the main reason is that dividend growth investing is often easy, passive, and not very stressful in comparison to other types of investing

It can take a lot of work to find a company that offers good dividends that is worth investing in, but once you find this company, you essentially purchase the stocks, let them sit, and watch the money roll in. This is especially true if you have your trading website set up to automatically reinvest your dividends into new shares for you. And if you are trading with a quality app for stock trading, this should definitely be an option for you. 

Although it was previously mentioned that dividends aren’t always a display of how well a company is doing, there are many cases where companies simply make too much money to continually re-invest it in themselves. These are the companies that should be offering dividends, and if you find a company like this, there is no reason not to invest in them. 

The Dangers of Dividend Growth Investing ⚡

Just like almost any type of investment you may decide to place in the stock market, dividend growth investing does have many risks. And this is because it isn’t just the healthy companies offering dividends, and it can be easy for a company to hide how it is paying its investors. That, and dividends issued by a company are highly dependent on the government interest rates.

If Interest Rates Fall, So Do Dividend Stocks 📉

To understand why dividend stocks rely on the government for success, you need to look at the situation from an investment point of view. When you are faced with two investments, one into Company A with a 4% dividend yield, or one in the US government with a yield of 1.3%. 

Well of course you would invest in Company A. This is because although an investment in Company A is riskier, its yield will let you beat inflation while the government bonds will not. 

Now, if the government decided to raise the rate on their bonds to 4%, well now you have a problem because investors will flock to purchase US government bonds instead of Company A. Why? Because the two now yield the same, and from an investor’s point of view, the government is a safer investment than Company A which could go under. 

This means if the government raises its bond yields even a percent, there’s a chance that the prices of dividend stocks could fall due to loss of demand causing you to lose your hard-earned money. US government bonds used to yield 1.75%,which seemed reasonable to investors, but when the rates dropped to 1.15%, this is simply not worth an investor’s time or money.

U.S. treasury bond
U.S. treasury bond yields have been dropping betweens 2019 and 2021 as a result of extremely low interest rates. Image by TradingView.

This caused investors to flock back to dividend growth stocks, because they could make more money, even though most stocks only yield 2-3%. But if the government raises their rate to 2.15% it is highly likely the same investors that abandoned the government bonds when the rate dropped will return right back to their previous, more safe investments. This will cause dividend stocks to drop in price. 

This is one of the biggest risks with dividend investing because the US government will always trump most dividend stocks, meaning even if you are diversified in several different dividend stocks, an increase in the government interest rate could send them all tumbling. 

Dividend Stocks Don’t Always Perform Well Long Term 📅

Although there are a few companies out there that do offer dividends and continue to offer them long-term, these companies are few and far between, especially in the age of innovation where the consumer landscape is changing on a daily basis. 

While dividend stocks used to have a daily long shelf life of decades, the average dividend stock usually only offers a decent return for an average of 15 years or less. Only 6% of companies on the market currently continue to offer dividends for more than 15 years. 

This means that if you invest your retirement savings in dividend stocks, that you could easily lose your dividend, and the company could go belly up (costing you everything) before you even reach retirement. This can have you starting all over with your portfolio (and no money) in your late 40’s, and you don’t want to worry about that. 

Many Shady Companies Offer Dividend Stocks 🕵️

As has been said time and time again, it isn’t hard for a company to offer dividends. They can offer them from their revenue, they can acquire debt to give out dividends, and they can give them from falsely created cash flow. This means that many companies will offer dividends for the sole purpose of getting you to invest in order to drive their stock prices up and get more money for them to spend. 

Unfortunately, the type of company that is doing this is more common than not in the dividend growth market. This means your chances of buying a stock with reasonable dividends from a company that is financially capable of paying those dividends is very rare. 

And when you invest in a shady company, the chances of the majority of your savings going out the window at some point are quite high. You will need to perform fundamental analysis to weed out shady companies, and even then you may find yourself being swindled by a company you thought was performing well. This means dividend growth investment typically isn’t worth the risk.

🔍 FYI: To help narrow the search, some traders use premium stock analysis software—these are handy, and often free tools for filtering out bad stocks quickly.

Policy Changes Are Common 📃

The final danger of dividend stocks is perhaps the least concerning, but it must be pointed out that companies that offer dividends are allowed to change their policies at any time. Thus, if you take a large portion of your savings and put them in high dividend stocks on Monday, the company could decide on Tuesday to stop offering dividends.

While this may not seem like the end of the world, investors that are investing solely for that dividend aren’t going to like this policy change on Tuesday. And they may decide to move all their money to a new dividend stock by Wednesday, causing the stock price to fall and you to lose a large portion of your savings overnight. 

Of course, companies don’t like doing this, but there have been numerous occasions of this happening in the past. In early 2020, several high dividend brands such as Dutch Royal Shell and Dunkin Donuts cut their dividends or eliminated them completely, shocking investors who had been accustomed to receiving dividends for years. 

Dividend Growth vs. Value Investing ⚖️

If you are wishing there was a less risky alternative to dividend growth investing right about now, you’re not alone. The good news is, there is a way to invest in companies called value investing

Value investing is different from dividend growth investing as rather than searching for a company that offers the best dividends, you will be looking for companies that are currently undervalued on the market. This means you will acquire the stock at a reasonable price, with the hopes that it will grow, and make you money in the future. This style of investing was made popular by none other than Warren Buffet. 

What Are the Upsides of Both Investing Styles? ✅

One example of dividend growth investing is what happened to Amazon stock in 2018. Due to policy changes between the US and China, Amazon experienced an unparalleled stock dip as investors began to fear for the health of the company. If you were smart enough to see past this, and invest in the dip (also known as value investing) you would have been quite pleased when the company recovered within 6 months and went on to reach an all-time stock high. 

Both dividend growth and value investing involve researching a company. But in value investing, you have fewer variables to worry about, as you are simply looking for an overall good company that has maybe hit a rough patch, that you believe will come back. Meanwhile, for dividend growth investing, you need to analyze why a company is doing well, where its money is coming from, and if it will continue to do well—which leaves much more room for error. 

As you may know, more risk comes with more reward, and this is most certainly true in dividend growth investing success stories, such as those who invested in Altria Group (stock ticker MO) in 1987. At the time, the company was offering an impressive 14% yield. 

And despite all odds, they maintained this yield for 17 years. Meaning that a $10,000 investment in MO in 1987 would have netted you over $700,000 in dividends alone by 2015 even after the great recession in 2008. And that is no small chunk of change.

Yet there’s no minimum amount when it comes to dividend investing. Investing an amount as low as $1,000—or even lower—is possible, given the prevalence of fractional shares today.

What Are The Downsides of Both Investing Styles? ⬇️

Just as both types of investing methods can go well, so too can they both go wrong. As far as value investing goes, you may have seen Sears take a dip in 2005 due to their pending merger with Kmart. 

Many investors assumed the stock would rally and flocked to invest. While it did rally after this event, the stock hit an all-time high in 2006 only to begin a massive tumble it would never recover from. 

And if, during that same time period, you decided to invest in dividend stocks, you would have been very impressed by General Electric’s 12% dividend yield. And this would have served you well until the early 2010’s when the stock began to struggle with the spreading of renewable energy and solar panels. In 2017, GE cut their dividend to just 1% per share, causing investors to head elsewhere and the stock to tumble to just $14 a share. 

The point is, both value investing and dividend stock investing have their risks and their rewards, and you need to be aware of both before you engage in either. Below is a chart to help you further decide which investment style is best for you and your wallet.

Comparison FactorValue InvestingDividend Growth Investing
Data That Must Be ConsideredCompany HealthCompany Health, Dividend Yield, Company Cash Flow, Debt to Income Ratio
RiskLess RiskyMore Risky
Taxes You Will PayAs Low as 0%, Typically under 10%Possibly up to 20%
Things You Need To Watch For After PurchaseCompany ChangesGovernment Policy Changes, Company Policy Changes, Company Health
Generates a Passive IncomeNoYes
Can Make You MoneyYesYes

Conclusion 💡

If you want to make some extra money while you enjoy your free time, then dividend growth investing is definitely something you should consider. But besides just looking at the massive pile of coins you will get to add to your lair, you also need to consider all of the risks that may be involved. 

Dividend growth investing can be tricky, but if you are able to pick companies worthy of your investment, then there is a possibility that it could pay off in the end. But if dividend growth investing seems just a bit too risky for you, don’t worry, as value investing is a great alternative that can also make you money if you pick the right company. 

Regardless of which style of investing you choose to use to grow your portfolio, remember that investing is a risky business, but with higher risk, there can often be a high reward!

Dividend Growth Investing FAQs

  • How Do I Make $1000 a Month in Dividends?

    To make $1000 a month in dividends you will need to invest between $340,000 and $480,000 in a variety of stocks that have a posted dividend yield of between 2.5%-3.5%. The exact amount you will need to invest will depend if you are able to find stocks at the higher or lower end of the dividend yield spectrum. 

  • How Much Money Do I Need to Invest to Live off Dividends?

    Because it can take up to a $480,000 initial investment to even make $1000 a month, to be able to live off of dividends you will need to invest amounts over $1 million. 

  • How Does Dividend Policy Affect the Growth of a Firm?

    If a company offers higher dividends, this means they are giving away part of their profits that can no longer be reinvested into the growth of the company, thus slowing company growth. 

  • What is a Good Dividend Growth Rate?

    A good dividend growth rate is one that beats the rate of inflation. So if the inflation rate is currently 4.2%, a good dividend growth rate would be a stock that offers a dividend yield of more than 4.2%. 

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