When I started investing, one big mistake early on was thinking I had to “keep trading” to make more money.
I was stubborn as an ox.
I believed I could win big by doing frequent trades – chasing a few huge gains, riding through lots of volatility, and lots of churn in my portfolio. But it was tiring.
My spreadsheet would show big gains every now and then. But after factoring those inevitable losses – trades that didn’t work out – I realized my total returns weren’t worth the risk taking and huge amount of time spent.
It was tiring.
I thought picking good stocks alone was enough. But what I learnt is it also matters to let high-quality companies compound for dividends.
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Why dividend growth investing?
One of my biggest stock positions in my Dividend Grower Portfolio is Taiwan Semiconductor Manufacturing Company (TSMC). TSMC dominates a niche as a “pure-play” foundry.
It does nothing but produce the smallest microchips for some of the world’s biggest tech giants – Apple, Qualcomm and even Intel buy chips from TSM.
From a conventional income investor point of view, TSMC may not be the highest dividend yielding stock today. But it’s a solid dividend grower.
Over the past decade its dividends have almost tripled – growing from TWD6.00 per share to TWD17.00 per share.
If it continues to grow dividends at this rate, my dividend yield on purchase cost should continue to compound.
In fact, if one had bought TSMC (~TWD122/share) in 2015, the dividend yield on cost would have been around 13% yield today. That’s snowballing our dividend income.
When a company increases the dividend it pays you each year, your dividend yield based on your purchase cost rises over time.
That’s why when we pick high-quality companies Taiwan Semiconductor Manufacturing, the best thing to do is to do a Rip Van Winkle moment:
- Put it in our portfolio
- Sleep over it for the next decades
- Don’t get bothered by unnecessary news
This way, your original investment stays the same. But the income it generates for you keeps growing.
In the early years, this income may look modest. But after 10, 15 or even 20 years of consistent dividend increases, your portfolio could be generating far more income than what the original yield suggested when you first invested.
Feed the passive income machine
Next, more than simply picking high-quality companies, I grew my stock portfolio because I kept putting money into it. Dividend growth investing isn’t just picking high-quality dividend payers.
It’s consistently setting aside part of your active income today – whether it’s your salary, business income, other earned income – and putting them to work in durable businesses that grow their dividends year after year.
You become an investor that accumulates assets that generate income for you. In other words, I want to put money to “feed the passive income machine”.
Why time in the market matters more than timing for dividend investing
Many investors worry about missing the next big, growth stock.
Sure, these growth stocks could be the next Amazon, or even the next Facebook. And yes, I know by focusing on companies that gush dividends year after year, I might miss out on these next big, growth stocks.
The thing is, when you buy these growth stocks, you bet on a company that will be the next disruptor. You might pick fast-growing businesses with massive revenue growth, growing market share…
Yet many of these companies don’t make any profits, or any cash flow. There’s no proven business model. And for every winner like Facebook, there are thousands of other failed companies.
How often can I successfully pick these winners? I don’t know. While these companies can potentially disrupt markets, they are vulnerable to market disruptions early on too.
For example, Unity Software – best known for its game engine to create video games – had massive share price growth during the COVID-19 pandemic. Yet it fell over 70% over the last couple of years.
There’s nothing wrong with betting on growth companies. But I know I don’t have that expert knowledge to pick these early-stage companies.
What’s more, investing this way means I need to own at least a hundred of these stocks to diversify my risks. That’s too much time to watch my investments.
In a 1999 Fortune article, Warren Buffett said: “The key to investing is not assessing how much an industry is going to affect society (in my own words, disruption), or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.”
In my view, I find it’s far easier to pick a company that’s well-established, has a durable economic moat, making predictable profits, rather than try to guess a company that will attempt to disrupt the market.
I want my dividends to grow, and reinvest those dividends to compound my returns. Along the way, these durable businesses that pay dividends will also grow in capital gains. This is dividend growth investing:
- Dividends grow + reinvesting
- Share price gains
And I prefer compounding my returns over the long-term.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan
