Dividend growth investing is not for everyone. It is a specific style of investing that focuses on finding high quality businesses that have the ability to increase dividend payments year after year.

Dividend growth companies increase investors passive income as the company grows. Dividend growth investing generally appeals to long term investors who see the benefit of a steadyily rising passive income.

There is a select group of dividend paying companies that have paid increasing dividends for 25 or more years in a row. These businesses have proven they have a durable competitive advantage that allows them to grow revenue, earnings, and dividends year after year.

Many of these businesses are household names; companies like Wal-Mart, Coca-Cola, Johnson & Johnson and PepsiCo have all paid out increasing dividends well over 25 years in a row.

Do Dividend Aristocrats Outperform?

The Dividend Aristocrat Index is comprised of businesses with 25 or more years of consecutive dividend increases and that meet certain size and liquidity requirements.

The index has historically outperformed the S&P 500 by an average of 2.29 percentage points each year over the last decade. Surprisingly, the outperformance came with a reduction in risk. The Dividend Aristocrat Index has a 10 year standard deviation of 13.57% versus 14.69% for the S&P500

. It is rare in the investment world to find a strategy that yields higher returns while simultaneously reducing risk. Historically, investing in high quality businesses with a long history of dividend increases has done just that.

Warren Buffett & Dividend Growth Investing

There is no greater advocate for long term investing in high quality businesses that pay dividends than Warren Buffett himself. Warren Buffett’s portfolio is loaded with high quality businesses with a long history of Dividend increases.

All of his Top 7 positions (by percentage of portfolio) pay rising dividends. Four of his top 7 positions are Dividend Aristocrats with multi-decade streaks of dividend increases. These four holdings are:

  • Coca-Cola (KO)
  • Wal-Mart (WMT)
  • ExxonMobil (XOM)
  • Procter & Gamble (PG)

Warren Buffett backs up his investing style with several informative quotes that elucidate his investing style. One of his more revealing quotes is:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

Why is this so? Wonderful companies compound wealth over time, while fair companies may have short-term gains but lack the deep competitive advantage required to fend off competition and generate above average returns for decades.

Only the best businesses in the world have built such strong competitive advantages. A short cut to finding these businesses is to analyze their history of dividend growth. It is not possible for a mediocre business to raise its dividend each year for 25 years in a row as it doesn’t have the ability to grow earnings year after year.

Only a business with a strong competitive advantage can grow revenue, earnings, and dividends year after year. So what does Warren Buffett say about how long to hold a wonderful company after purchase?

“My favorite holding period is forever”

Warren Buffett argues that wonderful businesses compound your wealth year after year, and therefore should not be sold. The caveat to this is when/if the company loses its competitive advantage.

Alternatively, if a business is significantly overvalued it might be a good time to sell as well because the market is willing to pay significantly more value than the underlying value of the business.

Analyzing Warren Buffett’s Dividend Aristocrats

Two of Warren Buffett’s four Dividend Aristocrat stocks will be analyzed using the 5 Buy Rules from the 8 Rules of Dividend Investing. The 8 Rules of Dividend Investing use academically verified strategies that have historically improved return or reduced risk to find high quality dividend growth stocks trading at or below fair value.

The two stocks analyzed in this article are Coca-Cola and Wal-Mart. Both businesses have a long history of profitable growth and have well recognized brands to most US consumers. Both companies will be analyzed qualitatively, then quantitatively.

Wal-Mart: Undervalued Industry Leader

Wal-Mart is the world’s largest discount retailer with a market cap of $244 billion. The company trades at a P/E ratio of under 16, which is significantly lower than its competitors.

For comparison Costco has a P/E ratio of 27, Target has a P/E ratio of 25, and Dollar General has a P/E ratio over 19. Wal-Mart is significantly cheaper than its peers despite its size advantage due to its recent streak of disappointing comparable store sales results in the US.

Comparable Store Sales Analysis

Wal-Mart posted flat comparable store sales for its most recent quarter in its US based Wal-Mart stores. These flat comparable store sales were actually the highest the company has seen in 6 quarters. This is the first quarter in 6 where Wal-Mart US has seen positive comparable store sales data.

Sam’s Club has fared better than Wal-Mart US, but has still seen mediocre comparable store sales growth. The company had flat comparable store sales growth this quarter, following 2 consecutive quarters of declines.

Comparable Store Sales
Quarter Wal-Mart US Sam’s Club
2015 Q2 0.00% 0.00%
2015 Q1 -0.01% -0.50%
2014 Q4 -0.40% -0.10%
2014 Q3 -1.30% 1.10%
2014 Q2 -0.30% 1.70%
2014 Q1 -1.40% 0.20%
2013 Q4 1.00% 2.30%

Wal-Mart’s International division is doing much better than its US division. The company’s comparable store sales for its top 5 international markets are shown below. Notice the strong comparable store sales growth in its most recent quarter, a reversal from poor comparable store sales in the previous quarter. Wal-Mart is trending in the right direction internationally with favorable comparable store sales.

Comparable Store Sales

Quarter UK Canada Mexico Brazil China
2015 Q2 2.00% 1.90% 0.20% 9.70% -1.60%
2015 Q1 -1.50% -2.60% -1.40% 4.40% -2.50%

Wal-Mart Future Growth

Wal-Mart’s future growth will come from further penetration into emerging markets, new store concepts in the US, and through global e-Commerce growth.

The company grew international sales by 5.3% year over year on a constant currency basis in its most recent quarter. Wal-Mart should continue to grow internationally as it uses its strong cash flows to build more stores in faster growing emerging markets.

The bright spot for Wal-Mart US this quarter was its strong comparable store sales growth in its neighborhood market stores, which were up 5.6%. Neighborhood market stores are about one quarter the size of Wal-Mart super center stores.

They focus on grocery items as opposed to the ‘one-stop-shop’ concept of Wal-Mart super centers. Wal-Mart is on track to open between 180 and 200 new neighborhood market stores in the US this year. Wal-Mart’s success with its neighborhood market concept has shown the company that smaller stores emphasize ‘fill in the gaps’ between its larger super centers.

Following Wal-Mart’s success with smaller stores, it has unveiled a new concept. Wal-Mart’s new express store layout is about one-tenth the size of its super center stores. The express stores will have gas stations, a drug store, and a dollar store style general merchandise area.

Wal-Mart’s size and scale advantage will give its new express stores lower prices than competing dollar stores. Wal-Mart plans to open about 90 new locations in fiscal 2015. Wal-Mart US CEO Greg Foran said they have seen “continued solid comp sales performance” out of Wal-Mart express stores during the company’s conference call.

The company’s new smaller store concepts will likely drive US growth for the next several years. The company’s e-Commerce division also offers exciting growth potential.

Wal-Mart grew e-Commerce sales 24% in the second quarter compared to the second quarter of last year. The company gained market share in the competitive U.S. e-Commerce market.

Wal-Mart recently released its Savings Catcher which gives customers the difference of prices on items purchased at Wal-Mart compared to competitor prices if Wal-Mart did not have the lowest price. The savings catcher is another way to tell customers “we have the lowest prices, and we will prove it to you”.

In addition to double digit e-Commerce growth in the US, Wal-Mart also saw double digit e-Commerce growth in Brazil, Mexico, and Chile. More impressively, Wal-Mart saw triple digit revenue growth in Canada and Argentina.