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Quality And Value Through Dividend Growth

2021-05-14, Richard Fortin

Over the past several years, much has been written about the relative outperformance of growth vs. value, with growth stock returns exceeding those of most other equity categories during this period. Against this growth backdrop, the appeal of dividend investing appears to have lost its lustre in the eyes of some investors. There is a perception that dividend paying companies are often stodgy mature businesses lacking re-investment opportunities, therefore exhibiting inherently lower relative growth prospects. Nonetheless, not all dividend strategies are created equal and identifying and including long-term dividend growth companies in investment portfolios can yield tangible benefits.

In simple terms, dividend growth measures the rate of increase in a company’s dividend over time. A dividend growth investing strategy cares not only about the payment of regular dividends – but seeks out companies that can grow dividends over the long term. Businesses which produce consistent dividend growth invariably skew toward the higher end of the quality spectrum – generally enduring franchises with a track record of earnings and cash flow growth over successive market cycles while also exhibiting conservative capital structures. History has shown that holding dividend growers within a diversified portfolio can yield numerous benefits including superior risk-adjusted returns, lower downside capture during periods of market volatility, lower valuation risk, and access to a growing and inflation-adjusted income stream. Dividend policy ultimately remains a tool in management’s capital allocation toolbox; however, striking a balance between re-investing in the business for growth and committing to shareholders in the form of growing dividends can produce attractive share price returns.

The S&P 500 Dividend Aristocrats Index (‘SPDA’) is an equally weighted benchmark of 65 US dividend growth stocks diversified across 11 market sectors. Index membership requires that companies have increased their dividends annually for a minimum of 25 consecutive years. As such, it is a reasonable proxy to evaluate the merits of a dividend growth strategy. Over the past 10 years, the SPDA has produced an average annualized return of 14.3% vs. the S&P 500 (‘SPX’) return of 14.2% over the same period. Risk for the SPDA (as measured by the annualized standard deviation of monthly returns) was only 12.8% vs. 13.6% for the SPX over the same period. On a calendar year basis, the SPDA outperformed or produced comparable returns to the SPX in 7 out of the past 10 years. Today, the SPDA exhibits lower valuation risk vs. the SPX with lower price-to-earnings, price-to-book and price-to-sales valuation multiples, while its dividend yield of 2.3% exceeds the SPX yield by 90 basis points.

Recently published findings from BMO Capital Markets’ dividend growth strategy screen produced similar results, with returns from its group of dividend growth stocks consistently exceeding those of high dividend yield equities and the SPX during periods of market strength, while also limiting downside during periods of heightened market volatility. From a valuation standpoint, BMO’s dividend growth stocks also maintain a relative advantage to the broader market and currently trade at only 80% of the SPX earnings multiple – in line with historical averages.

Source: BMO Capital Markets Investment Strategy Group, FactSet

Dividend growth stocks figure prominently across multiple QV strategies. UnitedHealth Group (UNH), held in QV’s global equity strategy, is a leading U.S.-based provider of healthcare products and services. Through vertical integration and scale, the company has achieved an industry cost leadership position and has strengthened its value proposition to its growing base of members. UNH’s balanced approach to capital allocation has allowed for profitable re-investment in the business while also producing one of the top dividend growth track records of any holding in QV portfolios – with 5-year and 10-year compound annual growth rates of 21% and 28%, respectively. Cummins (CMI), one of our US holdings, is a global manufacturer and distributor of diesel and natural gas engines and related engine parts. Although CMI operates in a cyclical industry, the business exhibits secular growth characteristics and has compounded revenues, earnings and cashflow at above-average rates for nearly two decades. Similarly, its dividends have compounded at 5-year and 10-year growth rates of 9% and 20%, respectively. Both UNH and CMI have produced double-digit average annual share price gains over the past decade – indicative of sound capital allocation and underlying value creation. Going forward, we expect these franchises to retain their high-quality attributes and continue to produce growing dividend streams.

As US equity indices continue to trade near the upper end of their historical valuation ranges, the combination of quality and value is becoming increasingly difficult to uncover. Dividend growth stocks provide a unique window into high-quality and resilient franchises that offer competitive returns – often with lower risk. These attributes should make dividend growth stocks worthy of consideration for most investment portfolios.

All views and projections are the expressed opinion of QV Investors Inc. and are subject to change without notice. This Update is provided for informational purposes only. QV Investors takes no legal responsibility from any losses resulting from investment decisions based on the content of this Update.


Richard Fortin | Portfolio Manager, US & Global Equities

Richard oversees QV’s investment process and makes portfolio decisions for the US & global strategies.