Passive Income from Dividend Aristocrats: A Guide to Building Long-Term Income
When it comes to investing, there are many strategies to consider, but few can offer the long-term wealth-building potential of dividend aristocrats. Dividend aristocrats are companies that have a track record of increasing their dividends for at least 25 consecutive years. In this guide, we will explore the benefits of investing in dividend aristocrats for passive income, how to identify the best candidates, and how to maximize returns.
What are Dividend Aristocrats?
Dividend aristocrats are companies that have a long history of paying and increasing their dividends over time. These companies have demonstrated their ability to generate consistent earnings and cash flow, which they use to reward shareholders with increasing dividends. To be classified as a dividend aristocrat, a company must be a member of the S&P 500 index and have increased its dividend for at least 25 consecutive years. This is a challenging feat that requires sustained excellence in business operations and financial management.
Benefits of Investing in Dividend Aristocrats
There are several benefits to investing in dividend aristocrats for passive income.
First, these companies have a track record of stability and resilience, which can provide investors with peace of mind. By investing in companies that have weathered multiple economic cycles, investors can reduce their exposure to market volatility and potential losses.
Second, dividend aristocrats can offer a reliable source of passive income. As these companies increase their dividends over time, investors can enjoy a growing stream of cash flow that requires minimal effort on their part. This can be particularly attractive for retirees or those looking to supplement their income without having to actively manage their investments.
Third, dividend aristocrats have the potential to provide superior returns over the long term. According to a study by Hartford Funds, dividend-paying stocks outperformed non-dividend-paying stocks by an average of 2.5% per year from 1972 to 2019. This outperformance was even more pronounced for companies that consistently increased their dividends.
Identifying the Best Dividend Aristocrats
Not all dividend aristocrats are created equal, and it’s important to identify the best candidates for investment. Just because they are a dividend aristocrat does not mean everything is automatically hunky-dory. Doing your due diligence is essential. Here are some factors to consider when evaluating dividend aristocrats:
- Financial Strength: The first thing to look for in a dividend aristocrat is financial strength. This includes factors such as revenue growth, earnings growth, cash flow generation, and debt levels. Companies with strong financial moats are better equipped to weather economic downturns and continue to pay and increase their dividends.
- Dividend Yield: While dividend yield shouldn’t be the sole factor in your decision-making process, it’s still an important metric to consider. Dividend yield is the annual dividend payment divided by the stock price. A higher dividend yield can provide a higher level of passive income, but it’s important to ensure that the company can sustain its dividend payments.
- Dividend Growth: The primary reason to invest in dividend aristocrats is their ability to consistently increase their dividends over time. Look for companies that have a track record of increasing their dividends at a rate that outpaces inflation. This will ensure that your passive income stream continues to grow in value over time.
- Business Model: It’s important to understand the underlying business model of a company before investing in its stock. Look for companies with a competitive advantage in their industry and a sustainable business model that can generate consistent earnings and cash flow.
- Valuation: Finally, it’s important to consider the valuation of a company before investing. A high-quality dividend aristocrat may not be a good investment if it’s trading at an excessive valuation. Look for companies that are trading at reasonable valuations relative to their earnings and growth potential.
Examples of Dividend Aristocrats for Passive Income
Based on the criteria outlined above, here are some of the top dividend aristocrats for passive income at time of writing this article (or you could just look at this fuller list here):
- Johnson & Johnson (JNJ): Johnson & Johnson is a healthcare conglomerate with a long history of increasing its dividends. The company has increased its dividend for 59 consecutive years, making it one of the longest-running dividend aristocrats. Johnson & Johnson has a diverse portfolio of products and services, including pharmaceuticals, medical devices, and consumer health products. The company has a strong balance sheet and generates consistent cash flow, which allows it to continue paying and increasing its dividends.
- Procter & Gamble (PG): Procter & Gamble is a consumer goods company that owns popular brands such as Tide, Pampers, and Gillette. The company has increased its dividend for 65 consecutive years, making it the longest-running dividend aristocrat. Procter & Gamble has a strong brand portfolio, which allows it to generate consistent earnings and cash flow. The company has also been focused on cost-cutting and improving operational efficiency, which has helped it maintain its dividend growth streak.
- Coca-Cola (KO): Coca-Cola is a beverage company that owns popular brands such as Coke, Sprite, and Fanta. The company has increased its dividend for 59 consecutive years and has a strong balance sheet and cash flow generation. Coca-Cola has been focusing on diversifying its product portfolio and expanding into new markets, which has helped it maintain its competitive position in the industry.
- PepsiCo (PEP): PepsiCo is a food and beverage company that owns popular brands such as Pepsi, Frito-Lay, and Quaker Oats. The company has increased its dividend for 49 consecutive years and has a diverse product portfolio that generates consistent cash flow. PepsiCo has been focused on expanding its healthier snack and beverage options, which has helped it maintain its competitive position in the industry.
- ExxonMobil (XOM): ExxonMobil is an energy company that has a long history of paying and increasing its dividends. The company has increased its dividend for 39 consecutive years and has a strong balance sheet and cash flow generation. While the energy sector has faced headwinds in recent years, ExxonMobil’s diversified operations and cost-cutting measures have helped it maintain its dividend growth streak.
Maximizing Returns from Dividend Aristocrats
While dividend aristocrats can offer reliable passive income, there are ways to maximize returns from these stocks. Here are some strategies to consider:
- Reinvest Dividends: One of the simplest ways to maximize returns from dividend aristocrats is, whilst you are in accumulation mode, to reinvest your dividends. This means using your dividend payments to purchase more shares of the company. Over time, this can lead to significant growth in the value of your investment and your passive income stream.
- Buy at a Discount: While dividend aristocrats are generally considered to be stable and reliable, their stock prices can still fluctuate based on market conditions. Look for opportunities to purchase shares of dividend aristocrats at a discount, such as during market downturns or when the stock is trading below its historical average. N.B. This requires having cash put aside and on-the-ready for such an event.
- Diversify: While investing in dividend aristocrats can offer reliable passive income, it’s still important to diversify your portfolio. Consider investing in a variety of asset classes to reduce your overall risk.
- Monitor the Company: Even the strongest dividend aristocrats can experience challenges over time. It’s important to monitor the financial health of the company, changes in its business model, and potential threats to its competitive position. This can help you make informed decisions about when to buy, hold, or sell your shares.
U.S. Dividend Aristocrat ETFs
U.S. Dividend Aristocrat ETFs are a much easier way to invest in dividend aristocrats compared to stock picking.
Investors who are interested in dividend aristocrats but prefer a more diversified approach may consider investing in U.S. Dividend Aristocrat ETFs. These ETFs provide exposure to a basket of dividend aristocrats, which can help reduce the risk associated with investing in individual stocks.
For the record, I do not invest into individual dividend aristocrat stocks (despite the temptation!). I simply do not have the time to be continually researching and monitoring a portfolio of individual stocks – I have a life to live and enjoy. My preference is to use a dividend aristocrat ETF for simplicity. Your approach may differ however.
Here are some of the popular U.S. Dividend Aristocrat ETFs to get you interested in beginning your own research:
- SPDR S&P Dividend ETF (SDY): The SPDR S&P Dividend ETF tracks the S&P High Yield Dividend Aristocrats Index, which consists of companies that have increased their dividends for at least 20 consecutive years. The ETF holds 111 stocks and has an expense ratio of 0.35%.
- ProShares S&P 500 Dividend Aristocrats ETF (NOBL): The ProShares S&P 500 Dividend Aristocrats ETF tracks the S&P 500 Dividend Aristocrats Index, which consists of companies that have increased their dividends for at least 25 consecutive years. The ETF holds 65 stocks and has an expense ratio of 0.35%.
- Vanguard Dividend Appreciation ETF (VIG): The Vanguard Dividend Appreciation ETF tracks the NASDAQ US Dividend Achievers Select Index, which consists of companies that have increased their dividends for at least 10 consecutive years. The ETF holds 245 stocks and has an expense ratio of 0.06%.
- iShares Select Dividend ETF (DVY): The iShares Select Dividend ETF tracks the Dow Jones U.S. Select Dividend Index, which consists of companies that have a history of consistent dividend payments. The ETF holds 98 stocks and has an expense ratio of 0.39%.
- Invesco Dividend Achievers ETF (PFM): The Invesco Dividend Achievers ETF tracks the NASDAQ US Broad Dividend Achievers Index, which consists of companies that have increased their dividends for at least 10 consecutive years. The ETF holds 252 stocks and has an expense ratio of 0.54%.
Investing in dividend aristocrat ETFs can provide investors with exposure to a diversified portfolio of high-quality dividend-paying stocks. It’s important to do your due diligence and consider factors such as expense ratios, diversification, and historical performance when selecting an ETF.
As with any investment strategy, it’s also important to do your own thorough research. If you get confused or need help, then consult with a financial advisor who understands dividend growth investing before making any investment decisions. This guy may fit the bill – he is also an excellent youtuber on dividend growth investing. I do not often give a shout-out to youtubers, but this is an exception. (No, I do not get any kickbacks or affiliate earnings from this link).
Investing in dividend aristocrats can offer a reliable source of passive income and the potential for long-term wealth building. By identifying high-quality dividend aristocrats and maximizing returns through reinvestment, buying at a discount, diversification, and monitoring the company, investors can build a robust and diversified portfolio that can generate passive income for years to come.
For transparency, I use this approach in my 2nd portfolio mentioned here for income growth. For simplicity, I use a dividend aristocrat ETF as part of this portfolio.
As with any investment strategy, it’s important to do your due diligence and consult with a financial advisor if needed before making any investment decisions. While dividend aristocrats can be a great addition to any portfolio, they may not be suitable for every investor’s needs or risk tolerance.
In summary, dividend aristocrats can be a great way to generate passive income and build long-term wealth. By focusing on high-quality companies with a history of consistent dividend increases, investors can build a diversified portfolio that can weather market volatility and generate reliable returns over time.