Why the Dividend Aristocrats Make Excellent Long-Term Investments?

This is a guest contribution by Nick McCullum from Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to systematically identify and rank high-quality dividend stocks suitable for long-term investment.

The Dividend Aristocrats are a group of elite dividend stocks with 25+ years of consecutive dividend increases.The Dividend Aristocrats list contains 51 stocks, and many of them are household names: Coca-Cola (KO), Pepsi (PEP), Procter & Gamble (PG), and Colgate-Palmolive (PG) are notable examples.

What stands out about the Dividend Aristocrats is not their name recognition. Rather, these stocks have a number of characteristics that make them highly appealing from an investing perspective. This article will provide 5 detailed reasons why the Dividend Aristocrats make excellent investments to hold for the long term, especially for those who want to retire early.

Reason #1: They Have Historically Outperformed The S&P 500

The first reason why the Dividend Aristocrats make solid investments is because they have historically outperformed the broader stock market.

The following image compares the performance of the S&P 500 Dividend Aristocrats Index with the performance of the S&P 500 Index over the past decade. The outperformance of the Dividend Aristocrats is noticeable.

dividend aristocrats list

Over the past decade, the Dividend Aristocrats have returned 10.6% per year, while the S&P 500 has returned 7.4% per year. This represents more than 3% per year of outperformance, which is especially significant when compounded over long periods of time.

We believe that there are three broad reasons why the Dividend Aristocrats have outperformed the rest of the stock market historically.

  1. The first is quite simple: a company that pays dividends must be generating earnings or cash flows to distribute to shareholders. While unprofitable companies can pay dividends for short periods of time, long dividend histories – like those evidenced within the Dividend Aristocrats – requires the underlying business to be performing well. This means that the riskiest businesses – pre-profit startups or failing businesses – are excluded from being Dividend Aristocrats.
  2. Secondly, a business that consistently increases its dividends must be far more selective with the growth projects it takes on, because a portion of every dollar of cash flows is being distributed as dividend payments. Having such laser-like focus on capital allocation decisions likely adds to shareholder values.
  3. The third (and last) reason why we believe dividend growth stocks outperform is because cash dividends show that corporate management is willing to reward shareholders for their investment. This key sign that management is shareholder-oriented has a good chance of impacting their other behavior as well.

Reason #2: They Have Been Less Volatile Than The S&P 500

The outperformance of the Dividend Aristocrats over time – 3% per year over the past decade – is quite remarkable on an absolute basis.

On a risk-adjusted basis, though, the performance is even more spectacular. This is because the Dividend Aristocrats have actually had less volatility than the broader stock market despite delivering higher returns. The volatility of the Dividend Aristocrats over the past decade can be seen in the following table (note: the benchmark here is the S&P 500 index):

dividend aristocrats list

The Dividend Aristocrats Index has had an annualized standard deviation of 14.07% over the past decade, while the S&P 500 has had an annualized standard deviation of 15.14%. While the difference is not meaningful when looking at the direct numbers, it is much more significant after accounting for the Dividend Aristocrats’ higher average returns.

So, how have the Dividend Aristocrats managed to outperform with such little volatility?

A large factor, in our view, is the Dividend Aristocrats’ concentration in recession-resilient industries. While the Dividend Aristocrats is reasonably diversified across sectors, the list is somewhat concentrated in sectors (such as consumer staples) that have historically performed well over during recessions – which reduces long-term volatility. The sector diversification of the Dividend Aristocrats Index can be seen below.

dividend aristocrats list

The low volatility of the Dividend Aristocrats is another reason why this group of high-quality dividend stocks make such fantastic long-term investments.

Reason #3: They Are Designed For Long-Term Dividend Growth Investors

The Dividend Aristocrats, by definition, are all dividend growth stocks. The formal requirements to be included in the S&P Dividend Aristocrats Index are:

  • Be in the S&P 500;
  • Have 25+ consecutive years of dividend increases;
  • Meet certain minimum size & liquidity requirements;

It is the second requirement (25+ years of consecutive dividend increases) that make the Dividend Aristocrats lend well to a dividend growth investing strategy.

Why is this important?

Well, dividend growth investing is one of the few self-directed investment strategies that makes it easy to be a long-term investor. You can simply buy fairly-priced shares of high-quality dividend growth stocks and hold them for long periods of time. This allows investors to take advantage of the many benefits associated with investing for the long run.

Indeed, the power of long-term investing is hard to overstate.

“The single greatest edge an investor can have is a long-term orientation.” – Seth Klarman

Long-term investing allows you to minimize capital gains taxes, avoid brokerage commissions and other frictional costs, and – perhaps most importantly – spend less time managing your portfolio and more time on tasks that matter. The role that Dividend Aristocrats play as long-term dividend growth stocks are key to this endeavor.

Reason #4: They Are Usually Simple, Easy-to-Understand Businesses

Conventional academic theory suggests that an investor must assume excess risk to generate excess return. The outperformance of the Dividend Aristocrats combined with their lesser volatility proves that this is not always the case.

The Dividend Aristocrats are also an excellent example of the outperformance of simplicity. Many of the businesses contained within the Dividend Aristocrats have very simple business models that give investors the necessary peace of mind to buy them personally.

Having a thorough understanding of the business models of the companies you invest in is very important. Many of the most expensive corporate disasters in history (Enron, Worldcom, etc.) have come from companies whose business models were nearly incomprehensible.

The Dividend Aristocrats avoid this problem and allow investors to fully commit to the stocks that they own.

Reason #5: They Allow For Sufficient Diversification

When investors think of diversification, usually the first concept that comes to mind is the appropriate number of stocks to hold in an investment portfolio.

However, owning a large number of stocks is not enough if they aren’t diversified when it comes to sectors, geographies, and other meaningful factors. Importantly, the Dividend Aristocrats allow investors to create real diversification within their portfolio.

There are currently 51 Dividend Aristocrats. These 51 Dividend Aristocrats represent the following stock market sectors:

  • Consumer Staples;
  • Industrials;
  • Health Care;
  • Consumer Discretionary;
  • Financials;
  • Materials;
  • Energy;
  • Telecommunication Services;
  • Information Technology;
  • Utilities;
  • Real Estate;

Clearly, the Dividend Aristocrats allow for adequate cross-sector diversification – an important outcome for any self-directed investor.

Final Thoughts

The Dividend Aristocrats have many positive qualities that appeal to conservative, self-directed investors, and to those who want to retire early. They have delivered outsized performance with less risk, while simultaneously having many other qualitative characteristics that integrate well with a successful long-term dividend growth investment strategy.

For these reasons, we believe the Dividend Aristocrats make excellent long-term investment when purchased at fair or better prices.

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