Yesterday, while writing about sleep-well-at-night – or SWAN – stocks, I mentioned two key factors to consider when buying a company:
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The rate and consistency of earnings growth that a business model generates.
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The valuation (not the share price) that you pay for that business.
Today, I want to look closer at that first factor. Because, despite the current market madness that’s keeping so many traders terrified of buying anything…
It’s not that complicated to spot a stable company with strong earnings potential. One way to do that is to evaluate its dividend situation.
In the world of corporate finance, dividends are one of the core decisions a business must make. First, on whether to offer a dividend or not, then – if the answer is yes – how much to offer, how often, and when to raise that payout.
Some companies choose not to, which is their prerogative. And there are plenty of studies they can cite to back that kind of decision.
As for me though, I advocate former Harvard Professor Michael Jensen’s white paper, Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers. In it, he points out how a company with too much free cash flow can too easily make bad decisions.
It’s like a college student with an unlimited allowance from his parents. He’s more likely to spend that money on activities that could get him into trouble. Whereas he might think twice if he’s paying his own tuition.
In the same way, investors can benefit by owning companies that take a more conservative financial approach. The benefits show most clearly in times of market weakness.
The Truth About Dividends
Jensen, of course, put it much more academically in his white paper, writing that:
Payouts to shareholders reduce the resources under manager’s control, thereby reducing managers’ power and making it more likely they will incur the monitoring of the capital markets which occurs when the firm must obtain new capital.
Or, as the late and great Benjamin Graham – the father of value investing – put it in his book, The Intelligent Investor:
Paying out a dividend does not guarantee great results, but it does improve the return of the typical stock by yanking at least some cash out of the manager’s hands before they can squander it or squirrel it away.
The result falls squarely in investors’ favor on multiple levels.
In fact, going back to 1960, 85% of the cumulative total return of the S&P 500 Index can be attributed to reinvested dividends and the power of compounding.
Source: Hartford Funds
Ned Davis Research studied the subject further, comparing companies that tend to raise their dividends to those that don’t. As it turns out, the dividend growers realized an annualized average 10.2% return between 1973 and 2023. Whereas those that kept their payouts flat only achieved 6.7% returns.
Source: Hartford Funds
That means investing in companies with a record of raising their dividends pays off twice over: through the actual payouts and general share price appreciation.
But there’s yet another benefit to buying and holding dividend-growing companies…
They signal corporate strength and management discipline that helps their stakeholders sleep well at night. And the more years they raise those dividends, the more likely they are to keep doing so in the same intelligent and sustainable way as before.
Personally, I like to see dividend growth that’s greater than the rate of inflation, which is currently sitting at 2.4%. Though it might very well increase in the near future considering Trump’s tariffs.
All things considered, I like to see companies boost their payouts by an average 5% per year – at least – provided they’ve got a good track record of being able to pay for it while still growing the larger business.
Two Dividend Growers on My Radar
There are over 2,000 publicly traded companies that pay dividends today. But far fewer really stand out in today’s environment.
CareTrust (CTRE) is one that does.
This health care-oriented real estate investment trust (“REIT”) owns 406 properties in 34 states. It generates 59% of its revenue from skilled nursing facilities, with the rest coming from multiservice properties, senior housing, and financing.
CTRE is smaller than many of its peers, but it generates noteworthy investment spreads. For instance, its weighted average growth runs at 10% while its weighted average cost of capital is just 5%.
This gives it impressive adjusted funds from operations, or AFFO, (i.e., real estate-oriented earnings) per share. And, as shown below, CTRE has grown its dividend by around a 7% compound annual growth rate over the past nine years.
Source: Wide Moat Research
Shares are now trading at fair value with a price to AFFO multiple of 17.8 times. So this is one to put on your watchlist to see if it falls just a little bit more into bargain territory.
The dividend yields 4.7%, and it’s well-covered by a 70% payout ratio. Meanwhile, analysts estimate shares will grow a whopping 16% this year and 11% in 2026.
Next up is Iron Mountain (IRM), another REIT. It’s a well-known global leader in storage and information management services, with a total addressable market of $150 billion.
In 2024, IRM generated $6.1 billion of revenue from over 240,000 customers, including many on the Fortune 1000 list.
What’s especially interesting here though is the company’s transformation. Over the last decade, Iron Mountain has expanded into data-center storage. Its 416 megawatts (“MW”) of “space” is now 96% leased, and it has another 165 MW worth under construction.
As such, analysts are forecasting 10% growth in 2026 and 2027.
Admittedly, Iron Mountain didn’t increase its dividend from 2020 to 2022. Management was hoping to improve its balance sheet and reduce the payout ratio to be in line with industrial REIT peers.
Considering how its payout ratio was around 82% in 2019 and it’s now around 63%… I’d say that attempt was successful. And it’s faithfully gone right back to raising its dividend.
Source: Wide Moat Research
Even so, shares – which hit an all-time high of $126.70 last October – closed at $81.61 yesterday. That’s a completely unjustified drop but one that interested investors should evaluate as a very tempting entry point.
Don’t Discount the Power of Dividends
I know it’s hard to care too much about dividend stocks when the market is rocking like it was the past few years. But those dividend stocks pay out the whole entire time, nonetheless.
And when the party stops and it’s time to pay the tab, they’re just as good for the money.
Really, it’s times like this that prove my case for owning the right dividend growth stocks. And my team at Wide Moat Research is eager to highlight the best of the best amidst all the uncertainty.
That’s why we’re even now in the process of incorporating dividend screeners within our research platform – so our customers can enjoy even more stress-free investing.
It’s also why we recently launched our own YouTube channel: to give you one more way to find reassurance and advice. This Thursday, we’re focusing on SWAN stocks…
So if you haven’t done so already, please subscribe to The Wide Moat Show today!
Regards,
Brad Thomas
Editor, Wide Moat Daily
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