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!
Timely article for me right now, Jason!
Ability and Willingness to pay a dividend! So true!
I do not understand a lot about tech stocks, therefore I said no thanks to tech stocks until now. Risk comes with what you do not understand.
I studied Texas Instruments (analogue semiconductors and embedded processes … yeah well) but I was convinced by their ability and willingness (and I understand, that TXN is a fast growing market .. IoT etc. and they are very well positioned):
Ability to pay a dividend: Oh yes … EPS payout 50%, FCF payout 40%, amazing balance sheet (debt etc)
so .. CHECK
Willingness to pay a dividend: Oh yes … on TXN ir you find that statement:
“We’ve committed to return all of our free cash flow to shareholders through dividends and stock repurchases.”
And TXN delivers with a 24% increase this year … which is in line with the 5y growth rate.
Willingness … CHECK
Best of all … TXN is quite on sale right now as the yield inching towards historic dimension.
May I ask, why you do not own TXN ?
Best wishes and have great evening over there!
Thorsten
Thorsten,
Absolutely. Ability is very, very important. But one shouldn’t discount the willingness side of the equation.
As for your question on TXN (which isn’t at all related to this post), this reminds me of a tweet I just sent out the other day relating to two emails I received that same same day. The first email went along these lines: “You own too many stocks. How can you possibly keep up with all of them?” The second email went along these lines: “You don’t own a lot of great stocks yet. Any reasons you haven’t bought X, Y, and Z?” Fortunately, other people’s opinions don’t really impact or matter to me.
https://twitter.com/JasonFieber/status/1049673469527379968
To sum it up, capital is limited (even if ideas aren’t). And I’m no longer aggressively buying dividend growth stocks to achieve FIRE (because I’ve already achieved it). It took a hell of a lot of capital, focus, research, and time to accumulate what I have. However, I still invest here and there, partly because I greatly enjoy the process. I’m sure I’ll end up owning slices of even more great businesses in time. TXN, in particular, is on my radar. That said, if I were to suddenly be unable to buy more stocks, I’m pretty comfortable with the 100+ businesses I’m invested in already. I wouldn’t be heartbroken about it. I’m not obsessed with money or stocks. As my philanthropy continues to scale (as I age), investment will naturally curtail anyway.
Cheers!
Jason, many thanks for your reply and the link to twitter (just hit follow).
Well, I brought TXN up in this context, because your article mirrored my previous impression.
I bought TXN exactly for the very reasons you wrote about: being able, being willing!
I fully understand and have the very same problem (too many stocks, not enough cash) and I even have another issue, as I want to limit portfolio size to 20 positions only – serves my discipline enormously.
So please view my comment as a compliment!
Regards!
This article touches on a very key point. Many would argue that a companies willingness to pay a dividend handicaps them since it means that the pool of opportunities for available growth projects is low and investors won’t be able to compound as fast due to this.
Generally companies with the more mature and established business models are the ones paying out the growing dividends. So there is less of a need to reinvest all of the cash generated by the business and only the most attractive projects are chosen.
I view the proven business models that have high switching costs or consumer stickiness as a strength.
Like you, I believe that a long trend of consistent growth rate makes for a fantastic investment as it’s better to compound at a moderate rate for long and steady periods of time than it is to have hyper growth for a few years followed by a collapse in the business model.
And I am a big believer in companies sharing their profit with their rightful owner, the shareholder. I really like the example of the employer paying the workers in scrip but not cash and that approach not being able to go very far at all.
I likely miss some big winners by sticking to this type of investing but I’m not too bothered about that. It’s enough to suit my needs and looking at my track record of dividend growth over the past years, it’s nothing short of amazing. In other words, it suits my needs perfectly.
-Mike
Mike,
You’re right. I noted in the article that I knew upfront that I’d miss out on some winners. But I also knew I’d miss out on a whole lot of losers. Growing dividends tends to cut the noise out for me, making that choice (winners/losers) much clearer. It’s just a much more advantageous percentage of winners against losers, all while collecting growing passive dividend income along the way. To each their own, but I have no qualms with my results. 🙂
That example I gave in the article (the worker collecting stock) is about as clear as I can make it. That’s probably my favorite thing I’ve ever written on this subject.
A lot of people think the growing dividends handicap the business, but that’s often not the case at all. The AMGN/BIIB dynamic shows that well. Really depends on the business, but the growing dividends serve as a pretty good litmus test for business quality.
Regardless, this conversation is delving into the academics of it, which is something that’s pretty much been beaten to death by now. I just wanted to point out that investors (especially those just starting out) shouldn’t make the mistake of overly concentrating on ability at the expense of willingness.
Best regards!
Hey Jason
A really great article to read. I hadn’t ever thought about it in that manner ability and willingness. It is very true that a company be willing and able to do both. I do think you are very correct if that I am going to put my money with a company. I expect that company to have the ability and the willingness to pay me a ever growing dividend. I personal wish companies would decrease some of the stock buy backs and increase the dividend more. Buy backs are nice but dividends are better in my opinion. I agree on the SJM picked some up the other day a little over $103, and see this as a long term good buy.
Also just bought you book the other day, and only have time to read a few pages. I have to say so far so good of what I have read, and advice you put in there. I hope I can get my son to read it. I think he will get a lot out of it. I can’t wait till I get time to finish your new book up.
Cheers.
Michael,
Thanks. Glad you enjoyed it! 🙂
Yeah, I want to know any company I invest in is both able and willing to pay me that growing dividend. Circumstances change, and times can get tough, so I want to have some kind of confidence going in that there’ll be a willingness even if the ability starts to deteriorate a bit.
Hope you enjoy the book. It’s a bit of an “extreme” guide, but many of the ideas can be applied in a more moderate manner.
Best wishes.
Hi Jason,
With some companies you can also experience too much of a good thing in dividend over-willingness.
I love pipeline companies but know some will shoot their credit rating down to junk trying to keep the dividend train rolling while taking on ever-growing debt to build up the business.
In this instance you have to be the grown-up in the room and spot when they’re biting off more than they can chew despite the pro-DGI talk, got burned by that one a couple of times before the lesson stuck.
Regards,
DN
DN,
Well, there’s always an exception to every rule. But it’s usually a business-specific case.
For example, in the pipeline space, ONEOK kept right on pumping those dividends straight through a pipeline into my brokerage account back when the MLPs were really struggling. They kept that dividend/growth streak intact, and it’s turned out to be a fantastic investment. Ability and willingness go hand in hand. They’re complementary. The latter shouldn’t forsake the former, and vice versa. But it’s nice to know that a company is willing to step up when times get tough.
Cheers!
I very much like your point about human nature and how people are typicall not very good at handling more money than is necessary for a given task. This is something I’ve thought for a very long time, and the flipside of this type of discussion often comes up by those who are strongly against dividend investing. Usually at this point the math comes out and they show how a stock is losing potential value if the dividend is paid out rather than retained by the company for further business growth. And this makes perfect sense in a purely mathematical sense. But that’s assuming the company is being 100% efficient with the money that would have otherwise been paid out.
Yet, time and again we hear about companies wasting money on ridiculous things like golden toilets or flying a second empty private jet in case the CEO’s primary jet breaks down. (Both real examples). For me, I want the company to “show me the money” and let me decide how to deploy or waste it. Yes, they may be sacrificing some ability to grow. But once a company reaches a certain critical mass, there isn’t much additional growth it can do anyway.
Scott,
We’re on the same page.
Your first paragraph is all academics. I don’t bother with those discussions/debates any longer because they serve my life no value. Frankly speaking, it doesn’t behoove me at all to convince anyone to buy my stocks. I’d rather they didn’t. Keeps them cheap for me (and the companies buying back that stock). Ha! 🙂
But it comes down to marginal propensity to consume. It’s very easy to understand. Human nature being as it is, I know that people are quite a bit less efficient than 100% with excess capital. If corporations were run by robots, OK. But they’re not. They’re run by human beings.
Best regards.
Jason,
I wish more investors would put their foot down and demand their fair share of profits. I have never understood the argument that some people make claiming that dividends are unimportant or that share buy backs are just as good. The fact is, if there is no dividend being paid then the value of the stock is the hope that it will pay one out one day. Otherwise we are just buying a piece or art or a collectible, hoping that someone else will come along in the future and pay more money for our shares just because they want to collect it like a baseball card. Madness.
When it comes to stock buybacks, they are better than nothing at all, but nowhere near as good as a dividend. A stock buyback is good for one thing only IMHO, and that is to lower the payout ratio so that the company can pay more dividends in the future in an easier manner. Stock buybacks give shareholders no choice. The company is saying, I’ll give you your money back, but only if you re-invest it into the same company immediately. The worst part is that companies are notorious for giving out stock buybacks when the p/e and p/b are too high, and a sane investor would choose to deploy that capital elsewhere or sit on it for a better time to buy more shares. So, I say no thank you to stock buybacks.
When it comes to reviving my fair share of profits, I want it in cold hard cash, because its *my damn money* and I get to decide what to do with it.
It really takes no effort at all for shareholders to demand fairness. I use two index funds primarily and that requires zero effort at all (of course I pay for that convenience when the ER eats into my dividends). The two index funds I own have a very simple algorithm mainly based on market cap and kicking out any company that is not paying a dividend.
If your not paying a dividend then “hit the road jack”.
jh,
Haha. Right. Hit the road! 🙂
I think there’s an argument to be made for buybacks, but it depends on valuation. And, in my view, it can and should be used in conjunction with a dividend. Berkshire does the buyback thing pretty well (although they’ve recently expanded their parameters), but there’s obviously no dividend there.
It’s really all about proper allocation of capital. I’ve always maintained the idea that a growing dividend is generally a good use of capital in most cases because human beings are prone to overspending if there’s more capital than necessary to complete a task. If that weren’t the case, the world would look a whole lot different than it does today. And a growing dividend thus sets a nice precedent regarding allocation, shareholder value, etc. The fact that it’s such a fantastic source of growing passive income really seals the deal.
But to each their own. It’s never behooved me to convince anyone to buy these stocks. If anything, it’s the opposite.
I only put this piece together to show that it’s important to pay attention to both ability and willingness. It can’t be just one or the other. A great deal of both is necessary for a stock to be a really great dividend growth investment over the long run.
Best regards.
Hello Jason,
I was wondering if it was my question last week regarding FB and Google that prompted the article? If so, I am happy I was able to provide some inspiration to you. It was probably numerous questions along the same line. Anyway, as always I do enjoy your articles and we own many of the same stocks, about 85% of my stocks are dividend growth stocks. I do leave some room for Google, FB, and Amazon as well though. Thanks for posting.
Luka,
Ha!
Your specific question didn’t prompt the article. Instead, your question was only the latest in a long line of such questions I’ve been hearing for about six years now. The straw that broke the camel’s back, as they say.
In the end, everyone has to invest in a way that best suits them. I’m only writing this as a dividend growth investor for dividend growth investors. If you want some kind of hybrid strategy or whatever, go for it! 🙂
Best regards.
Even if the articles aren’t written entirely for my strategy, I still enjoy them just the same. I am mostly a dividend growth investor with a few growth stocks sprinkled in for good measure, with the “hope” that they one day show a willingness to pay a dividend. They have the ability. What you have accomplished in such a short period of time should be an inspiration to all investors.
Luka,
Appreciate the support and readership. If you can glean something from my writing, even if it’s not 100% applicable for you in all situations, I’m more than happy about that. 🙂
Everyone should manage their money/investments in a way that behooves them. It sounds like you made a choice that makes sense for you. Wish you the best of luck with it!
Cheers.