Much has been said about the Dividend Aristocrats, probably too much. But to get to the point of this piece, we’re going to need to talk about them a bit more.
So, let’s examine some of the good and bad aspects of the aristocrats.
Simple set of rules for index composition that are easy to understand
Consistent dividends and some dividend growth
Generally assumed to be safe investments
Big well-known companies that people love to talk about
The dividend yield is too small
The dividend growth is too low
They are kind of boring
We can do better
Keep in mind, the interesting part of this article is building the new dividend portfolio not debating why we shouldn’t just put all our eggs in the NOBL ETF and call it a day.
First things first, we need to discuss the elephant in the room, why try and fix something that isn’t broken? After all, S&P 500 Dividend Aristocrat Stocks have had a good showing over the years. They’ve given the general S&P 500 index a walloping. And keep in mind around 50 of the best performing stocks in the S&P 500, are the dividend aristocrats, pull those out and it looks even better.
And it’s important to remember that we have been in a structural bull market for the past eight years. High growth stocks have been mopping the floor with, well, everything else. And many of those growth stocks don’t pay dividends. So the performance is even better all things considered.
But is the performance as good as it could be or can we build a better dividend portfolio? And if we can, shouldn’t we?
I think the answer to both those questions is yes. And there is some strong evidence to support it. Let’s consider a few factors:
Small stocks beat large stocks, and the aristocrats are all very large
High dividend yielding stocks beat low dividend yielding stocks, the aristocrats are mostly low yielding
But, extremely high dividend yields do not outperform, as this often indicates unsustainable levels and dividend cuts
This is because stocks with very high dividends are often the result of large price declines because of a negative structural shift in their business.
So there is a sweet spot that we will need to find for our dividend portfolio, high yield is good, just not too high
Now, back to our pro’s and con’s.
The Dividend Aristocrats are boring, granted part of the allure is that they are boring. After all, some of these companies have been in existence since the Stone Age. I am fairly certain before a merger or two and a couple name changes along the way it was actually Procter & Gamble who sold the cave men chalk for their little drawings.
But, big old companies often suffer from additional layers of bureaucracy, may have conglomerate discounts and confusing financials that are impossible to truly understand, and are more likely to carry huge pension liabilities.
Let’s not forget what we learned from General Electric’s recent fall from grace; a splendid example of what’s not to like from a supposedly stable and safe dividend stock.
The point of a dividend portfolio is to get large sustainable payouts that grow over time.
But the average Dividend Aristocrats yield is in the 2.5% range, insufficient to accomplish what most of us are setting out to do. In fact, that’s insufficient to even cover typical (perhaps not current) inflation rates.
So we’ll need to get that yield up, but not by sacrificing quality. Investing is about trading off risk and reward, but we can get more reward without taking on more risk in our dividend portfolio.
It’s not just about the current yield either, we’re going to need dividend growth, to give us increasing dividends over time. Over the past five years the average dividend growth CAGR for the dividend aristocrats has been 10%, the median is a bit lower at 8%. This level is acceptable, but we’ll look to improve on it.
The bottom line is that the dividend aristocrats offer a very attractive place to start, but are in no way an optimal portfolio from either a risk or reward perspective. The dividend is insufficient to finance most investors income requirement. As we go forward we will keep using the Dividend Aristocrats ETF as a benchmark for our own portfolio, and we will be focusing on achieving greater returns without greater risk.
This is the first article in a series where we will build out a dividend portfolio from scratch. Be sure to subscribe (using the email submit to the right) and stay tuned as our dividend portfolio develops. In the next piece we’ll be discussing how to narrow the investment universe for the portfolio.