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Getting quantitative about dividend growth [ClearOnMoney]
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Getting quantitative about dividend growth

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Commentary

Getting quantitative about dividend growth

2 Jan 2012 by Jim Fickett.

Many investors like stocks for which the dividend has consistently grown over time. Certainly dividend growth is a good thing, but one should go beyond the existence of growth, and make a quantitative analysis of future inflation-adjusted dividend value. One of my holdings, WGL, brags that dividends have consistently grown since 1973. But the present value of future dividends is not enough to justify the current stock price (up significantly from when I bought).

From time to time one sees reports emphasizing the value of companies that consistently grow the dividend over time. For example, I wrote a post about Oppenheimer research on this topic in April 2010 (The importance of dividend growth); S&P maintains an index of “dividend aristocrats”, “that have followed a policy of increasing dividends every year for at least 25 consecutive years”; and Mergent publishes a Handbook of Dividend Achievers, that have “increased their regular cash dividends annually for the past ten or more consecutive years”.

One of the companies in my portfolio, WGL Holdings, a utility, is quite proud of their record in increasing (or at least holding steady) their dividend every year since 1973. When I bought WGL (Buying another dividend stock: WGL) I also pointed to this fact as a positive. However as I recently began taking another careful look at the stock (it is up quite a bit and perhaps overvalued now), I began to wonder to wonder about inflation.

In most cases it is some work to dig up the dividend history, but WGL is kind enough to have the whole dividend history displayed conveniently on their website. In the graph below the long-term history of dividends paid by WGL is plotted, both in nominal dollars and in inflation-adjusted, “real” dollars. As can plainly be seen, when inflation is taken into account, steady increases over the long term turn into gentle decline – though, to be fair, the dividend has come pretty close to holding its real value.

One would really like the dividend to hold its real value. There are two things to say about this. First, averaged across the market, dividends apparently do keep up with inflation (Dividends as an inflation hedge). That suggests it is possible to find companies that increase the dividend in real terms over time.

Second, I'm sure WGL is not the only company increasing the dividend just enough to maintain their record, but not enough to keep pace with inflation, and yet the Oppenheimer, S&P, and Mergent research all shows that, on average, companies that consistently increase the nominal dividend outperform the rest of the market. Probably that means even companies like WGL that fail to keep up with inflation have decent performance. Perhaps the ability to meet even the weaker, nominal benchmark shows a certain level of both management competence and shareholder orientation.

On WGL in particular, what is that dividend really worth in the long run? Suppose they can keep up the current trend for another 10, 20, or 30 years. Over those three time periods the dividend might be worth perhaps 10*$0.65 = $6.50, 20*$0.62 = $12.40, or 30*$.60 = $18.00 in 1983 dollars, or $15, $28, $41, respectively, in 2012 dollars. The current stock price is $44. So even assuming they keep up current trends for another 30 years, it is hard to see the stock as a bargain on the basis of the net present value of the dividend alone. In other words, the dividend is nice, but you can't really make the case for buying or holding this stock on the basis of the dividend alone.

Footnote: you have to buy a Mergent report to see their list. However there are several ETFs based on the Mergent research and their holdings are, of course, public information. That could provide the starting point for some interesting research.