Building A Core Dividend Growth Portfolio With These Eight Companies

PRINCIPLE#2: FOCUS ON DIVIDEND GROWTH

My second investing principle relates to dividend growth as being the most important metric of all. It doesn’t only prove management’s trust in the company’s future but it is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

This is why I focus on the company’s dividend payment history. In order to maintain dividend growth year after year, a company must show the following fundamentals:

Solid business model;

A protected economic moat;

Increasing cash flow;

Increasing revenues;

Increasing earnings

A great company showing the perfect dividend growth profile is Genuine Parts Company (NYSE:GPC). This company is part of the highly selective Dividend King group which includes only companies that has been consecutively increasing their dividend payment for at least 50 years.

Through a great combination of organic growth and growth by acquisitions, Genuine Parts Company (NYSE:GPC) was able to extend its business year after year and rewarded their investors at the same time. The automobile parts industry is a repetitive business enabling consistent growth and Genuine Parts Company (NYSE:GPC) benefits from a great expertise in acquiring smaller competitors.

PRINCIPLE #3: FIND SUSTAINABLE DIVIDEND GROWTH STOCKS

Now that I know I should focus on dividend growth and not dividend yield, I need to find indicators telling me this growth will continue into the future. As investors, we are more concerned about the future than the past. This is why it is important to find companies that will be able to sustain their dividend growth. This is where I take a look at three main trends:

#1 the dividend payment

#2 the payout ratio

#3 the cash payout ratio

I’ve selected Procter & Gamble Co (NYSE:PG) to show you the difference between the payout ratio and the cash dividend payout ratio:

This graph shows me how their dividend payments evolve over time compared to the company’s ability to pay them. The most important thing is to consider the cash payout ratio instead of the most known payout ratio. Because net earnings can be easily manipulated and cash flows are harder to manipulate, this ratio is useful to analyze cash flow being paid in dividends.

Therefore, you can clearly see that even if Procter & Gamble Co (NYSE:PG) posted lower earnings in the past couple years (leading to higher payout ratio), the cash dividend payout ratio has been relatively stable around 60% for the past four years.

PRINCIPLE #4: THE BUSINESS MODEL ENSURES FUTURE GROWTH

While looking at payout ratios will give you some hindsight about the future dividend growth of the company, metrics don’t tell you everything. Another way to validate if a company will be able to maintain its dividend growth rate is to analyze its business model. I often tend to look at companies that have a strong economic moat or that show hard-to-replicate competitive advantages.

A good example meeting this investment principle is the asset manager BlackRock, Inc. (NYSE:BLK). BLK has the largest market share for assets under management (AUM) and is a leader with its iShares division. With over $1 trillion invested in its ETFs, Blackrock shows more than double the AUM of the second-place State Street Corp. (NYSE:STT).

BlackRock, Inc. (NYSE:BLK) offers a variety of products from fixed income to equities, therefore, when a mass of investors are leaving equities to move toward fixed income, BlackRock continues to sell them investment products. With new legislation coming from the Department of Labor (DOL), employers will have to offer low-fee investment solutions for retirement to their employees. Large asset firms such as BlackRock, Inc. (NYSE:BLK) will benefit from these new rules.