The easiest strategy for market beating returns

Beat the benchmark with dividends

Hi Everyone,

You don't have to be a stock-picking genius to outperform the market, and honestly, this kind of thinking causes more harm than good because it promotes overconfidence in an area where you need to be purely analytical. I see it all the time: Investors look for the next bargain or growth company, only to abandon it a few months later when the price does not move in the expected direction, although they were confident that this is the one.

Instead, you must internalize that you have alternatives. There are numerous investment options you can use. Many people are unaware of the abundance of opportunities available to them. You are not bound to any specific stock or investment strategy. While there are numerous ways to skin a cat, I'd want to focus today on what I believe to be the simplest one that you can implement in a portfolio strategy:

Dividend Stocks.

Dividend-paying stocks are like the Volvos of the investing world. They’re not fancy at first glance, but they have a lot going for them when you look deeper under the hood. Finding companies with a history of increasing dividends, especially those with clear and robust dividend-growth plans, has traditionally allowed investors to capture high performance. Such companies' stocks have routinely beaten the S&P 500 SPY 0.00%↑ Index while carrying less risk.

“Dividends are an elegant value indicator as they favor companies that at least make a profit.”

As I often preach, the first step to stock market profits is not to hunt for individual stocks, but rather to fish in the proper pond to enhance your chances of making a good pick. Let’s first take a look at dividend payers in general. The average contribution of dividend income to the total return of the S&P 500 Index from 1930 to 2021 was 40%. A decade-by-decade analysis of the performance of the S&P 500 Index reveals that the impact of dividends has fluctuated significantly over time:

Dividends supplied a large portion of total returns during the 1940s, 1960s, and 1970s, when total returns were low. As a result, they provide an excellent defense plan during unpredictable times. Rather than attempting to rebalance their portfolios during a market downturn, investors can easily use dividend payers to stay one step ahead and prepare for difficult times. On top of that the psychological aspect of staying calm and not panic-selling shouldn’t be overlooked.

Always ask yourself what Cathie Wood or Jim Cramer would do before making any investment choice, and then do the opposite. Which pond would they fish in? The dull one with mature enterprises that expand slowly but steadily and reward patient shareholders with dividends, or the exciting one with no fundamentals, no dividends but a future-focused story? Let’s take a look at how each pond has performed over a longer period:

Since the beginning of the backtest, there is a distinct divide. By investing in stocks that do not pay dividends, you not only expose your capital to risk, but you also pass up potential profits. There are companies that have never paid a dividend and still outperformed stocks that increase their dividends each year, but that’s not my point. Exceptions do not disprove a rule; rather, they demonstrate the extent to which a rule applies. And investing is all about repeatedly applying rules that have worked in the past.

You have a group of 100 stocks that pay dividends and another group of 100 stocks that do not pay dividends. When you choose from the winning team, you simply have the odds on your side because the former group has historically outperformed the latter group. Therefore, let’s focus on the best team:

Dividend Growers & Initiators

Companies with a history of increasing dividends are a good place to start when looking for fundamentally strong and growing companies. Consistent profitability and shareholder-oriented management are often accompanied by dividend growth. A track record of dividend increases can be interpreted as a sign that a company's management is both willing and able to increase shareholder payouts in the future. This commitment implies that quality fundamentals currently exist and that future development is planned.

Over the backtest period, dividend growers demonstrated lower volatility and higher returns than other categories of dividend stocks in the S&P 500 SPY 0.00%↑. Regardless of the level of inflation, whether the economy was in recession or expansion, or whether the Fed was raising or lowering interest rates, performance was relatively strong. Although markets as a whole were affected by these factors, dividend growers' relatively strong performance was evident. On top of that, it's not uncommon for such companies to have double-digit dividend growth rates. Few jobs offer such an automated income increase.

How to find winners early on

While Dividend Aristocrats (companies that raised their dividends +25 years in a row) are a good starting point, I prefer to be one step ahead. How can we identify future dividend aristocrats? By investigating Dividend Challengers (companies that have raised dividends between 5 and 9 years in a row). Companies that have only recently begun to pay dividends or have only been increasing dividends for the past 2-3 years, in my opinion, have not proven themselves. I value dependability and safety.

5 to 9 years of dividend growth commitment is a good indicator that management is on track to continue this policy and that company fundamentals have consistently improved during those years. Below you’ll find a current list of those companies:

Dividend Challengers

Final thoughts

An allocation to companies with sustainable and growing dividends provides exposure to high-quality stocks and higher income over time, potentially mitigating market volatility and mitigating the risk of rising interest rates. When a company is consistently able to increase its dividend for years or even decades, it indicates a certain level of financial strength and discipline. Dividend growers are also a useful tool for investors who are concerned about volatility but want to stay invested in equities while earning some income. They are the low-hanging fruits that wait to be picked.

I hope you learned something today, until the next issue. 👋

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