Dividend contenders are a group of stocks that consist of companies that have increased their dividends for at least 10-24 consecutive years. As of June 2022, there are 348 companies that belong to this club.
Dividend contenders fall between dividend challengers which have increased their dividend for five to nine years and dividend champions that have increased their dividend for at least 25 years. What all of these companies have in common is that the only requirement to achieve their particular status is that they have raised their divided for the required amount of time.
In this article we’ll explain the significance of dividends and why dividend contenders are an appealing option for investors.
What is a Dividend?
When you buy stock in a company, you take an ownership stake in the company. A dividend takes that one step further by distributing a percentage of its profits (known as the payout ratio) to investors as a dividend for owning the stock.
Many companies pay a dividend every three months (i.e. a quarterly dividend). That means that investors earn this dividend on a regular schedule no matter what is happening with the company’s stock price.
Why Do Companies Pay a Dividend?
Companies that pay a dividend usually do so because they are at a point in their business cycle that puts some upside limit on their growth. This doesn’t mean that the companies are in financial trouble. Many of these companies are large-cap companies that generate billions in revenue and have consistent earnings. They have sound balance sheets and generate significant free cash flow (FCF).
The downside of this consistency is that the companies don’t deliver the same growth as companies that are involved in sectors that deliver disruptive technology. And for that reason the stock price of these companies tends to underperform the overall market.
To help offset this relative lack of stock price appreciation, these companies will help increase their shareholders total return by issuing a dividend.
Dividends Help Increase Total Return
The total return on an investment includes interest, capital gains, dividends and other distributions that an investment generates over a period of time. If a company doesn’t issue a dividend, the total return of that investment is almost exclusively limited to capital gains. When the market is going up, these stocks can outperform the market. However when the market is in a correction or a bear market, the total return on these stocks can be significantly lower than broader market.
By contrast, dividend stocks offer investors a dividend in addition to the opportunity for capital gains. This has a smoothing effect on many portfolios. While these stocks may not outperform the market in terms of capital gains, the dividends can help move them closer. But these stocks really shine in times of market downturns. In this case, the stocks tend to perform “less badly” than growth stocks. In addition, the “rent” that investors collect from the dividend can help trim losses even more.
That’s because in most cases, investors have the ability to reinvest their dividends. This increases the amount of stock an investor owns which increases their capital gains as well as increasing their dividend payout. This creates a wealth-building cycle.
How Dividend Contenders Help Investors Avoid a Yield Trap
Dividend yield is the amount of company’s current annual dividend per share divided by its current stock price. If a company has a stock price of $150 and pays an annual dividend per share of $3 it has a dividend yield of 2%.
A common mistake that investors make is to believe that a dividend yield by itself is an indicator of a good dividend stock. But a company’s dividend yield reflects the current dividend payout and the current share price. Both of those variables can change.
Sometimes a company’s stock price drops based on short-term challenges. But sometimes it indicates more fundamental problems with the company. In these cases, investors may find themselves in a yield trap in which they bought shares of a company that is destined to underperform the market.
A better way to evaluate the security of a dividend is to monitor its dividend payout. Ideally investors want to see a payout ratio that is staying the same or growing. Dividend contenders have increased their dividend payout for at least 10 years. Once a company makes that kind of commitment it is likely to continue to prioritize its dividend.
Some Final Thoughts on Dividend Contenders
Identifying dividend contenders is a sound strategy for building the income side of your portfolio. Not only do these companies have reliable, growing dividends but they’re likely to be companies that will offer some stock price appreciation that will boost an investor’s total return.
However, like any stock, there are times when a dividend contender will underperform or outperform the market. Therefore, getting the most out of dividend contender requires a willingness to hold on to these stocks over time.