Dividend growth investing has treated me very well over the years.

I’ve been able to build out my FIRE Fund, which currently generates the five-figure and growing passive dividend income I need to pay my basic bills in life.

That has rendered me financially free in my early 30s, which led to moving abroad and living out my early retirement dreams in Thailand.

Life is good. 

I decided many years ago that investing only in companies that reward me as a shareholder with my rightful share of growing profit, to be the only reasonable way to invest.

It’s the most pragmatic and sensible way I could think of to allocate my capital over the long run, while simultaneously making sure I could generate the most passive income possible to become FIRE.

I knew I’d miss out on some winners here and there by avoiding companies that didn’t pay a growing dividend, but I also knew that I’d be casting aside a lot of losers. That’s a trade-off I’ve been more than willing to make, and the success I’ve achieved in such a short period of time, at such a young age, means I have no regrets.

Now, as a dividend growth investor who’s been steadily investing in high-quality dividend growth stocks since early 2010, I’ve been fortunate enough to learn a few lessons and become a better dividend growth investor over the last eight or so years.

One lesson I’ve learned is how important it is for a company to be both willing and able to pay a growing dividend.

When I first started investing, I was a little too focused on the ability part of the equation.

Said another way, I was heavily looking at the numbers in a very quantitative way. EPS, FCF, payout ratio, etc.

That’s all fine and dandy. And it’s no doubt very important.

But it’s just as important to be mindful of the willingness part of equation, which is obviously more qualitative in nature.

I’ll break it down very simply for you guys…

If a company isn’t able to pay a growing dividend, that means it’s probably not running a quality business.

It’s definitely not producing enough growing profit to fund a growing dividend. A lack of ability naturally means a lack of great quantitative fundamentals.

And if a company isn’t willing to pay a growing dividend, that means it’s keeping my fair share (as an owner) of that growing profit for itself.

Maybe they’ll do okay with that money. Maybe not. But I want my fair share. They can keep half or so to reinvest in the business – any rational investor should want to see a company keep a good chunk of its profit in order to continue growing, which ensures those growing dividends in turn.

But I don’t like a company keeping all of that profit. A company is ultimately run by people. And people, in my experience, aren’t very adept at handling more money than necessary for any given task.

I want my cash flow. No, I want my growing cash flow. I want what’s owed to me as an owner. 

Being a shareholder that isn’t collecting a growing dividend (or a dividend at all) would be like working for a company and being paid only in non-cash flow producing stock. Then you’re told the company is reinvesting all of its profit in order to grow the business. The money being diverted away from your paycheck might be put to good use, but there’s a chance it could be wasted on M&A, bad projects, unnecessary overhead, etc. You’re told maybe, just maybe, the stock you’re collecting will be worth more in the future – if a whole host of events outside of your control work in your favor. Then you can sell the stock they gave you in order to finally generate income. This process, by the way, could take years to play out.

“Well, gee, thanks, boss, but where’s my money?! Where’s the cash flow? I’ve got bills to pay, man.”

Moreover, and just as important here as it pertains to willingness, investing in companies that are devoutly committed to that dividend (and the growth of it) will surely benefit you when times get tough (and they always do).

If/when the ability starts to crack at the seams, you don’t want to be partnered up with companies that will make an unfavorable change to that dividend at the first sign of trouble.

See, it’s important to invest in companies that have both the ability and willingness to pay a growing dividend.

Lacking in the former means the business probably isn’t quality. Lacking in the latter means they’re selfishly keeping all of that money to themselves. Either scenario is no bueno for me.

I’m now going to break down both ability and willingness.

If you can master this concept and make sure you’re investing in companies that meet both criteria, I have no doubt you’ll go on to be a more successful dividend growth investor over the long term.

Ability

First up, let’s take a look at a company’s ability to pay a growing dividend.

There’s good news and bad news here.

The good news is that looking at quantitative data is quite simple. And this data has never been more accessible than it is today, making this process even simpler. One can pull up a 10-K in a few seconds and go to town.

The bad news is that you then have to extrapolate that data out into the future, which is where things get hard for an investor. If everyone knew what the future would bring, we’d all be perfect investors.

Nonetheless, the ability of a company to pay a growing dividend really comes down to just a few numbers.

You need to know how much money a business making per share, against how much money the dividend is costing the business per share.

Dividing the latter by the former gives you a payout ratio, which is expressed in percentage terms. It’s simply the percentage of profit (or cash flow) per share that’s being allocated toward paying a dividend.

Let’s say a company earned $5.00 per share over the last 12 months. And it’s paid $2.00 per share in dividends over that same time frame. Well, that’s a payout ratio of 40% (2/5).

All else equal, the lower the payout ratio, the safer the dividend is. A low payout ratio gives an investor a high degree of confidence that the company should be able to continue paying and increasing that dividend (because even an issue with near-term EPS growth gives the dividend some cushion).

Now, too low of a payout ratio probably means the yield is quite low. So one has to balance that payout ratio and ability to meet future obligations against the need for income today. It’s the classic “bird in the hand or two in the bush” scenario.

A high payout ratio usually comes with higher-yielding stocks, which is a case you often see with lower-growth companies that have stable cash flows. With limited growth opportunities, they end up sending a lot of cash shareholders’ way.

I personally diversify my way across companies across the spectrum of yield, which naturally means I’m exposed to companies with higher and lower payout ratios.

Likewise, I have exposure to companies with faster growth profiles, along with companies with slower growth profiles.

All of them meet different needs, because I have to think of both the Jason of 2018 (who needs that yield/income) along with the Jason of 2038 (who is going to need even more income to make sure he’s ahead on purchasing power).

The issue, as noted earlier, is that you have to extrapolate out current quantitative data into the future. By investing in a company, you’re essentially making a “bet” that they’ll continue growing enough in order to meet those future dividend obligations.

To see what these numbers look like when run through an an analysis, as well as to see what different ends of the spectrum look like, we’ll dive into two recent analyses I performed.

First, you can see the quantitative data on JM Smucker Co. (SJM).

The company has a payout ratio of below 50%, and the dividend appears to be very, very healthy. But the stock yielded 3.17% at the time of that analysis.

Meanwhile, the balance sheet is solid, the company is growing its bottom line at a decent clip, and the overall fundamentals are pretty strong.

I don’t see how one could doubt the ability for this company to cover their dividend in the near term, nor does there appear to be any indication that the dividend won’t continue to grow for the foreseeable future.

The ability is excellent. 

Now, you can take a look at the quantitative data on Altria Group Inc. (MO).

The company has a payout ratio of 82.7%, which means the dividend isn’t quite as healthy/sustainable as what you might see with JM Smucker.

However, this is a mature company that has long deftly operated with a higher payout ratio. In fact, management targets that higher payout ratio. As such, it shouldn’t be a surprise the stock yielded 5.44% at the time of that analysis.

The balance sheet is very solid, profitability is phenomenal, and the bottom-line growth is surprisingly good (especially considering the trends in volume and revenue).

Altria has long done well with its higher payout ratio, but a major hiccup in the business leaves it with little margin of safety on the dividend, for a compression in EPS would quickly elevate that payout ratio to a more uncomfortable range. That said, dividend appears to be more than OK here.

The ability is very good. 

We’ll next take a look at a company that isn’t able to pay a growing dividend (or a dividend at all).

That company is Tesla Inc. (TSLA).

The TTM GAAP EPS comes out to -$16.18. GAAP numbers can sometimes cloud things, but Tesla also registered FCF of more than -$4 billion last fiscal year. The TTM numbers aren’t much better.

This company is losing a lot of money.

Meanwhile, the fundamentals across all areas of the business are horrible. The balance sheet is carrying a lot of debt. And because the business is bleeding money, Tesla has to continue issuing more shares and debt in order to fund operations.

There is no ability whatsoever to pay a (growing) dividend.

Tesla has a fantastic ability to lose money, but there’s definitely no ability to reward their shareholders with a portion of growing profit (because growing profit is non-existent).

And so shareholders have to instead rely on the increasing of the share price in order to drive ROI, wealth, and even potentially income (assuming they’ll sell shares later).

Since the stock is trading for a price that’s very close to where it was in the spring of 2014, that hasn’t worked out terribly well. And unless the business turns around dramatically, the near term looks even worse.

Even if Tesla had a tremendous willingness to pay a growing dividend, its lack of ability would prevent them from paying one.

We can see now why ability is so important, but it’s not the only thing that’s important.

I’d say it’s just as important to look at a company’s willingness to pay a growing dividend.

Willingness 

A company’s willingness to pay a growing dividend goes hand in hand with its ability. The two are complementary.

And you, as a long-term dividend growth investor, need to make sure you can count on both ability and willingness from a company you’re investing in.

Moving back to those earlier examples, we might be able to conclude that JM Smucker has the better ability to pay a dividend than Altria.

But does it have more willingness? 

I’m not so sure about that one.

Now, willingness is obviously on the qualitative side of the analysis. So it’s up to an investor to decipher that and make a judgment call.

Greater ability can (but not always does) lend itself to greater willingness, but willingness can (and sometimes does) override ability when there are temporary, or even permanent, structural issues.

First, let’s consider that Altria has been paying out an increasing dividend for 49 consecutive years, while JM Smucker has been paying an increasing dividend for 21 consecutive years.

For my money, I believe Altria has the greater willingness.

They pay out a bigger dividend (both in terms of yield and in terms of the portion of EPS). And they’ve been committed to that growing dividend for a much longer period of time. They basically take that dividend very seriously, evidenced by the fact that they increased their dividend twice this year.

Trouble could strike both businesses. Maybe consumers stop buying JM Smucker products. Or maybe the volume trends for Altria deteriorate further.

If times get really tough for these companies, it seems to me that Altria is the more committed company. After all, they’ve dealt with basically a catastrophic drop in their customer base for decades, while the same thing obviously cannot be said for peanut butter or coffee consumption. And yet Altria was more than willing to do whatever was necessary to keep pumping out that dividend.

Both are fine investments. I like and own a slice of both businesses, for different reasons.

One has perhaps the greater ability. But ability does not necessarily convey willingness, and vice versa.

To further illustrate that point, we’ll now take a look at a company that has the ability to pay a growing dividend but no apparent willingness to do so.

Let’s take a look at Biogen Inc. (BIIB).

This is a massive biopharmaceutical company that has earns gobs of money and sports otherwise excellent fundamentals across the board.

If it paid a growing dividend (like, say, Amgen Inc. (AMGN)), the odds are pretty good it’d already be in my portfolio.

But despite registering GAAP EPS of $11.92 last fiscal year (and over $14 on a TTM basis), there’s no dividend here.

There’s an ability. There’s been an ability for many, many years now.

But there’s no dividend here.

That’s because there’s no willingness to pay one.

And so a shareholder in Biogen has to eventually sell off stock in order to generate any income from that holding.

Instead of collecting ever-more golden eggs from a golden goose, a Biogen stockholder has to slaughter the golden goose in order to eat.

It’s so much easier for me to own Amgen, which is another fantastic business in this same space, and collect that ever-growing pile of golden eggs, all while keeping the golden goose healthy and alive.

You could have bought Biogen stock five years ago on the hope it might initiate a dividend (due to a clear ability to pay one), but hope is not a very good investment strategy. And you’d be looking at empty hands as a result.

Or you could have bought Amgen stock five years ago because it clearly had the ability, and there was obviously evidence of willingness (as they were already paying a growing dividend five year ago).

You’d be looking at hands full of growing dividends as a result of that.

Plus, Amgen has absolutely killed Biogen in terms of total return over the last five years, which is just icing on the cake for a dividend growth investor.

Conclusion

What prompted me to write this article is a recent comment/question I received here on the blog, which is just like numerous comments/questions I’ve been receiving for more than five years now.

“What do you think about investing in Company X? They earn a lot of money. They don’t pay a dividend right now. But they might pay a dividend very soon.”

Sure, if you’re only looking at the ability of a company to pay a dividend, things might look great.

But if there’s no willingness to pay a dividend, the ability (i.e, the profit and other fundamentals) matter nil.

Likewise, investing in a company that’s been paying an increasing dividend for a few years now due to great ability (as the US economy has expanded) is great, but you have to really think about the willingness side of the equation. When things turn, you want to be confident that management team isn’t going to turn on you (in terms of paying a growing dividend).

As a dividend growth investor, it behooves you to pay attention to both ability and willingness (both now and into the future) when you go out and buy shares in a company.

Full disclosure: I’m long SJM, MO, and AMGN.

What do you think? Is it important to look at both willingness and ability? 

Thanks for reading.

Image courtesy of: Geerati at FreeDigitalPhotos.net.

P.S. If you’d like to invest in high-quality dividend growth stocks that have both the ability and willingness to pay growing dividends so that you can reach FIRE, check out some awesome resources that I personally used on my way to becoming financially free at 33!