Benjamin Graham is often called the father of securities analysis. He helped to train Warren Buffett, who is known as the Oracle of Omaha and runs Berkshire Hathaway(NYSE: BRK.B). In Graham's seminal book The Intelligent Investor, which was written for the average investor and not industry specialists, he suggests looking for companies that have paid dividends consistently for at least 20 years. It's a good plan, even though you can't control a company's dividend.
An up-front warning
Just because a company has a long history of supporting, or even growing, its dividend year in and year out does not mean the dividend won't get cut in the future. A great example of this is VF Corp.(NYSE: VFC). It had decades of annual dividend increases under its belt, but ended up cutting the dividend at the start of 2023.
That said, it's important to understand what happened. The apparel company spun off its basics business, which is now known as Kontoor Brands(NYSE: KTB). The basics business isn't a fast-growing clothing segment, but it is generally a reliable performer in both good markets and bad ones. Without that foundation, VF Corp. was left with a collection of fashion brands that are more subject to the fashion whims of consumers. Overnight VF Corp. became a much different company that simply wasn't as resilient to industry ups and downs. When some of its largest brands struggled, the board chose to cut the dividend.
That's the second big issue. A company's dividend is entirely at the discretion of the board of directors. There's nothing you can do to change it or know in advance what it will be. And yet Benjamin Graham said to look at a company's dividend history.
A strong dividend history shows financial strength
A dividend is paid out of a company's cash flows. If a company doesn't generate enough cash flow it simply can't keep paying a dividend over long periods of time. Sure, over a short period debt can be used to pay a dividend, but that's not sustainable for the two decades of dividend history that Graham suggested you examine. An even better screen is probably to look at stocks that have increased their dividends for decades, with the ultimate grouping being the Dividend Kings (50+ years).
But there are differences to keep in mind. For example, Universal Health Realty Income Trust(NYSE: UHT) has hiked its dividend annually for over three decades. That's impressive, but the average increase has been about 1.5% over the trailing 10-year period. That's much less impressive.
MCD Dividend Per Share (Annual) data by YCharts
Now compare that to restaurant giant McDonald's(NYSE: MCD), which just announced a roughly-10% dividend increase. The company has increased its dividend annually for 48 years and the average increase over the past decade was around 7%. Clearly that's a far more attractive increase than 1.5%, and based on the historical dividend growth it appears to be sustainable over time.
That highlights the really important takeaway: While you can't control a company's dividend policy, you can use dividend history to help guide you toward more attractive investments. A growing dividend is a sign of a company that is doing well enough to regularly increase its dividend. And more often than not, a fast-growing dividend will be a sign of a fast-growing company.
Take the next step
Before you run out and start buying up stocks that have strong dividend histories, remember the VF Corp. example from above. Sometimes companies cut their dividends even after raising them for years on end. A strong dividend track record is a first cut screen to limit the number of companies you consider. You still have to dig in and do your homework on each individual stock to ensure you understand the business and believe that the dividend is still sustainable in the future. But as Benjamin Graham made clear in his highly regarded investment guide, using dividends can help you focus your attention on where it will have the greatest impact. Dividend increases are great -- now use them wisely.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends Kontoor Brands. The Motley Fool has a disclosure policy.
