At Sandstone we have an 80/20 rule for equity investments. Equity exposure must be made up of a minimum of 80% dividend and dividend growth companies, and a maximum of 20% growth companies.
Sandstone Dividend Growth Investment Criteria
1. A minimum of 5 consecutive annual dividend increases or a minimum of 8 increases in the past 10 years.
2. Dividends must be fully funded out of free cash flow.
3. Must have both revenue and earnings growth.
4. Be in a healthy financial position – not over-leveraged.
5. Have a strong Return on Invested Capital (ROIC).
Dividend growth companies are a rare breed. A lot of companies pay dividends but do not exhibit the true traits of dividend growth.
true Traits of dividend growth
Constant dividend growth generally signals positive traits within a company which we call hallmarks of quality – stable earnings with growth, solid fundamentals, strong profits, and management teams with superior capital allocation skills.
Consistent dividend growers typically have management teams with conviction and long-term business expectations who balance both business spending for growth and shareholder returns.
Canadian Dividend Growth All-Stars
In Canada, we have 102 companies that have raised their dividend 5 or more times consecutively! These 102 companies maintained their dividend growth despite the world shutting down and business models being upended.
Canadian Utilities has the longest dividend growth streak with 49 increases. However, there are many companies increasing dividends annually that are climbing the list despite downturns in commodity prices, recessions, financial crisis, and pandemics.
Market values of these companies have had their ups and downs through various market cycles but their dividend growth has been positive and unwavering.
To name a few others in various industries which we have exposure to include:
- Canadian Natural Resources with 21 increases
- Brookfield Infrastructure Partnership with 13 increases
- Aliment Couche-Tard with 11 increases
- Bank of Nova Scotia with 10 increases
- Manulife Financial with 7 increases
- Wheaton Precious Metals with 5 increases
Dividends are a Major Source of Market Returns
Dividends are a very important part of investment returns. Over the long-term (1930-2017) dividends accounted for approximately 42% of the S&P 500 Index’s total return.
However, during inflationary environments, when interest rates are rising, dividends are typically a bigger component of returns. Remember the 1970’s when interest rates essentially doubled from 7% to 14%, dividends accounted for approximately 73% of the total return in the market during this time.
On the flip side, when interest rates are decreasing, such as we have just experienced over the past 10 years, dividends were a much smaller amount of total return at about 17%.
So, where do you think interest rates are headed over the next decade?
A Time and Place for Everything
Sandstone’s 80/20 rule provides portfolios with a blend of companies with large growth potential who may experience higher market volatility alongside more stable dividend growth companies. There is a time and place for everything.
Theoretically, growth stocks are reinvesting all their earnings and cash flow back into their business, which is growing rapidly. However, too much cash poses a big risk. It can be a drag on returns, which may push management to make poor capital allocation decisions, such as expensive acquisitions in pursuit of continued growth.
Companies are not immune from risks simply by paying a dividend. However, management who balance capital allocation for company growth, financial stability and shareholder return understand that capital is finite and they tend to make superior long-term business decisions.
Despite recessions, wars, commodity price shocks, technological shifts, and major changes in consumer habits, all-star dividend growth companies have been able to maintain and even grow dividends annually. These companies have proven to be stable, growing, cash-rich businesses that are resilient over time.
Dividend growth companies often exhibit hallmarks of quality that can contribute to a more resilient investment portfolio better able to weather market volatility. Dividends that you accrue are tangible and permanent benefits that no market volatility can undo.
As of May 2021, equity in growth portfolios was comprised of ~85% dividend and dividend growth companies, and ~15% growth companies.