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March 23, 2017

An Eye on Dividend Growth

By Richard Alpert, Raub Brock Capital Management

In achieving better stock market returns without taking unnecessary risk (the Holy Grail for stock investors), dividends matter. Over the past nine decades for which there is data, the majority of real returns from stocks have come from dividends. To pay a dividend, a company must deliver cold, hard cash to its shareholders. Corporate boards of directors that undertake the discipline of paying and increasing their dividends make better business decisions.

In data since the early 1970s studied by Raub Brock, dividend-paying stocks have outperformed non-dividend paying stocks nearly 55 percent of the time. When we factor in the significantly higher level of risk inherent in owning non-dividend paying stocks, the “risk-adjusted” outperformance by dividend-paying stocks rises to 75 percent.

But by itself, paying dividends is not the best indicator of which stocks provide the best potential long-term returns. More important than the level of the dividends is their sustainability. A recent study by a research team at Société Générale, the large French bank, concluded poor balance sheet quality is the best predictor of dividend cuts, and in our dividend studies, companies that cut or eliminated their dividends generated the worst returns.

To assure sustainable dividends, SocGen looks for financially robust companies, meaning those with both a strong balance sheet and a sound underlying business. SocGen concludes that low-risk, high quality companies have proven to be better investments than high-risk, low quality companies.

Too many equity managers are like lottery ticket purchasers looking for the big hit. Quality businesses are often boring businesses to follow, with simple, but healthy balance sheets. Because many equity managers and individual stock buyers look for excitement and are willing to overpay for it, unloved and unexciting “ho-hum” stocks are often under-owned and thus undervalued.

Our dividend studies indicate that the outperformance of dividend-growing companies is even greater than those companies that maintain a steady dividend. At Raub Brock, we strive to assure that we are buying true “growth” companies, ones that regularly grow their dividends, supported by reliable revenue and net profit growth. At the same time, we endeavor to look ahead to be sure that each company we own will be generating sufficient “free cash flow” (cash left over after paying expenses, including interest on a company’s debt) to be able to comfortably increase its dividend by 10 percent or more a year.

Western Growers Retirement Security Plan participants who elect to use Raub Brock can expect to own high quality mid- and large-cap companies that have a long history of paying dividends and have shown both a capacity and a willingness to grow their dividends over the long term. Our audited track record over the past 17 years shows that this approach to investing has generated significantly better risk-adjusted returns than a passive approach using a popular index such as the S&P 500. This approach has worked well in both up and down markets, but has been especially beneficial to investors during significant market downturns.