Growth investors should not overlook dividend-payers, as they can deliver superior portfolio results over time.
When it comes to investment strategies, ‘growth’ and ‘income’ are usually seen as very different beasts. But there is an argument to say that these approaches can actually be two sides of the same coin.
Dividends have been in turmoil in 2020. Economic uncertainty caused by Covid-19 triggered a wave of payout cancellations through the spring and summer. And while many are expected to bounce back, the dividend landscape has nonetheless been barren for investors looking for income.
But while income strategies have clearly suffered, there are still companies out there that are paying - and growing - their dividends. These might not be the classically high-yielding blue chips that many of us think about when it comes to dividends. But they are solid, profitable firms whose payouts potentially point to the kind of confidence that has been in short supply in much of the market this year.
- The staggering scale of UK dividend cuts in 2020 revealed
- Dividend boom over, but silver linings to 2020’s income cuts
- ii view: BAT’s dividend remains a major attraction
Jim Slater, the famous British growth investor, wrote in his 1992 book The Zulu Principle that he preferred companies that pay a dividend. He explained: “...the dividend payment and forecast (if any) to some extent corroborate the management's confidence in the future. The ideal company will have a steadily increasing dividend growing broadly in line with earnings”.
Slater’s point was that the dividend is a useful extra way of figuring out whether a company’s growth is likely to continue. Yet many growth investing strategies see dividends as a negative.
Indeed, a traditional view of companies that pay dividends is that they’ve simply run out of ideas to invest capital. In other words, they don’t know how to grow any further and may have even gone ex-growth.
More generally, there’s an assumption by growth investors that dividend-paying stocks actually deliver lower portfolio returns. But none of this is necessarily true. Research shows that higher-yielding stocks actually deliver superior portfolio returns over time.
The power of dividends
In his book Behavioural Portfolio Management, C. Thomas Howard makes the case for high-yielding stocks not only outperforming but also producing lower portfolio volatility. He argues that they do better, with fewer stomach-churning swings.
- ii view: Aviva's new sustainable dividend policy
- Are you saving enough for retirement? Our calculator can help you find out
Howard says that because dividends and dividend policy are almost entirely under the control of management, companies tend to be careful about paying out too much. They are keen to deliver progressive, sustainable payout growth. So, by increasing dividend payments, management is “actually signalling higher future cashflows, which in turn foretell higher stock returns”.
With these ideas in mind, this week’s screen covers one of the few dividend strategies that has netted a positive return in 2020. Dividend Achievers looks for long-term dividend growth in companies with growing earnings and good stock liquidity. A model of this approach tracked by Stockopedia has produced a consistently solid return over the past six years, with a 26.5% gain over the past two years and 7% gain over one year (before dividends and costs).
Here are some of the companies that currently pass the rules:
|Name||Mkt Cap £m||EPS 5y CAGR %||Div Gwth Streak||DPS Gwth %||Yield %||Sector|
|Eco Animal Health (LSE:EAH)||172.9||20.8||9||-||2.75||Healthcare|
|Concurrent Technologies (LSE:CNC)||70.8||16.3||9||6.25||2.64||Technology|
|Impax Asset Management (LSE:IPX)||946.8||28.4||9||56.4||1.18||Financials|
|Gamma Communications (LSE:GAMA)||1,426||27.7||5||12.4||0.73||Telecoms|
|Fevertree Drinks (LSE:FEVR)||2,589||86.5||5||-1.23||0.69||Defensives|
|Learning Technologies (LSE:LTG)||1,241||93.9||5||25||0.45||Industrials|
It’s important to remember that this isn’t a high yield strategy - rather it focuses on consistent growth in fast-growing companies. As a result you see higher quality small-caps like Eco Animal Health (LSE:EAH) and Concurrent Technologies (LSE:CNC) mixed in with larger players like Impax Asset Management (LSE:IPX) and Fevertree Drinks (LSE:FEVR).
Overall, the stocks passing these rules are likely to be profitable, high quality smaller companies, which may well be on relatively expensive valuations.
However, in the search for growth, the presence of a solid dividend track record paired with strong earnings growth has been shown to be a sound basis for portfolio construction. Smaller companies are not immune from having to make dividend cuts - and careful research is always important - but in the hunt for growth stock ideas it may pay to take more notice of the dividend track record.
interactive investor readers can get a free 14-day trial of Stockopedia by clicking here.
These investment articles are simply for generating ideas. If you are thinking of investing they should only ever be a starting point for your own in-depth research.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.