Dividend kings are an exclusive class of stocks made up of companies that have increased their dividends for at least 50 consecutive years. Investing in these companies is one of the most efficient ways for investors of all risk tolerances to build wealth over time. These companies demonstrate a commitment to building shareholder value by prioritizing raising the payout on their dividend. As of June 1, 2022 this exclusive group includes only 44 companies.
In this article we’ll explain the significance of dividends and why that makes dividend kings 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 is a Dividend King Different from a Dividend Aristocrat?
A dividend aristocrat is a company that has increased its dividend for at least 25 consecutive years. Dividend kings by contrast have increased their dividend for 50 years, in other words for twice as long.
A logical conclusion is that every dividend king is also a dividend aristocrat. But that’s not true. That’s because unlike companies that are part of the dividend aristocrat club, the only criteria necessary for a company to become a dividend king is that it has increased its dividend for at least 50 consecutive years.
By contrast, a dividend aristocrat must have at least 25 consecutive years of dividend increases and meet these additional requirements:
- Their stock must be listed on the S&P 500
- They must meet certain market cap and liquidity requirements. Currently, a company must have a float-adjusted market cap of at least $3 billion (meaning these are large-cap companies). In terms of liquidity, a dividend aristocrat should have an average trading volume of at least $5 million.
The Significance of Dividend Kings
The best of both worlds for dividend investors is to find companies that are not only paying a consistent dividend, but also increasing that dividend. This helps boost an investor’s total return and can be a way to offset the effect of inflation on an investment.
Dividend kings prioritize increasing its dividend over time. That makes them attractive to investors who have a low risk tolerance and are looking to build wealth slowly over time. And owning stocks of dividend kings can also help investors generate income in retirement when wealth preservation becomes a primary goal.
Are All Dividend Kings Good Investments?
It’s true that a dividend can increase an investor’s total return. However, it’s possible for a dividend king to be overvalued or undervalued. In bull markets, dividend king stocks can rise as part of the tide of investors sentiment that lifts all stocks. At the same time, quality dividend kings can get undervalued in bear markets.
The bottom line for investors is that dividend kings are ideal choices for an investor whose primary consideration is reliable income. But if you’re looking for capital appreciation and/or the largest dividend payout, there may be better options than dividend kings.