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5 High-Yielding Strong Dividend Growth Stocks for the Long Haul

We’ve never been more concerned about the financial health of dividend growth investors. Perhaps we’re partly to blame for some of the excitement surrounding the strategy that has taken many corners of the web by storm, but we continue to believe it is important for investors to strive to understand the strategy’s fundamental fallacies, which can’t be talked about enough as a means of helping investors understand key risks.

For those new to dividend growth investing, part of the strategy centers on identifying stocks that pay dividends that are poised to increase over the long haul, generating in time a yield (a payout) that is a) sufficient on the cost and b) sufficient to generate an adequate income in retirement years. This article cannot possibly capture all of the various ways investors may be using an equity-based income growth strategy, but we think for several, the common tenets below are worth emphasizing.

An informed investor is a better investor.

1. The Dividend Is Not A Driver Behind Stock Returns

As we continue to evaluate several studies on dividend growth investing and aggregate data for our white paper on the topic, to be published in coming months, one thing is clear: definitionally, earnings and free cash flow must be the primary drivers behind equity price performance. Though there are many examples that help explain this, we think one example is perhaps only needed to remember the spuriousness of the dividend to total returns.

What some investors may not remember is that in the mid-1990s, Apple completely eliminated its dividend, and the iPhone giant only recently reestablished the payout earlier this decade. Steve Jobs’ masterpiece has been one of the best performing stocks in the history of equity investing, and it’s simply difficult for us to ignore that the company eliminated its dividend in the past. Such a truism may not help investors that already understand that future earnings and free cash flow are what drives the equity valuation framework (and equity prices), but we think the example may be helpful to others as to why dividends are said to be a symptom (an output) of strong companies and their valuation paradigms—not a driver behind them.

In our view, it is misleading to say that Apple’s strong stock performance beginning earlier last decade was the direct result of the firm reinstituting a dividend nearly a decade later after the fact. By extension, we think it is equally misleading to say that any company’s strong returns over the past several decades have been a direct result of their dividend policies. The dividend growth investment framework may be suffering from one of the biggest statistically fallacies in investing history: Correlation does not imply causation. Said differently, it is more appropriate to say, in our view, that the strong performance of dividend payers has been (and/or should be) a direct result of expectations of continued strong earnings and free cash flows, not from a steadily-increasing dividend.

The elimination and re-initiation of a payout has been irrelevant to Apple’s total returns since its inception, as much as the absence of a dividend has been to Berkshire Hathaway’s total returns during the past many decades.

2. You Already Own Everything That a Company Will Ever Pay You as Future Dividends

A stock is a claim on a company’s assets, including net cash on the balance sheet, and all of the future earnings and free cash flows associated with such assets. Said differently, shareholders already own today, via the stock price (its intrinsic value), anything that a company will ever pay out as dividends in the future.

The very idea that a company will generate earnings and free cash flows in the future, for example, is why a company has any value at all today, and dividends are generally paid out as a portion of earnings and free cash flow. The payout of a dividend in this light is not an incremental value-driver to a company’s business; the dividend, as a portion of future earnings and free cash flow, is already captured in the value equation.

Valuation is and will always be independent of the dividend. Let’s explain this in personal-finance terms.

Many investors would agree that an...