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By Josh Peters, CFA and Jeremy Glaser | 10-29-2013 10:00 AM

Peters: Look Beyond Dividend Growth

Balancing above-average current yield with a history of dividend growth should help investors meet their total-return goals, says DividendInvestor editor Josh Peters.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. How should dividend investors weigh growth versus current yield? I'm joined today by Josh Peters, the editor of Morningstar DividendInvestor and also our director of equity income strategy, to take a look at this question.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: This balance between dividend growth and current yield, is this a real trade-off? Is this something investors need to be focused on when they're building a dividend portfolio?

Peters: Well, it always seems that I am pushing back against whatever the most popular theme of the day is, even within the universe of dividend-paying stocks. When people are really interested in those fat, juicy yields, then I'm the one that saying, "No, no, no. You always need to have at least some growth and you need good protection for the dividend." There's nothing better than a growing dividend to signal to you that the underlying dividend itself should be safe.

But at other points in the market, say when interest rates are going up and people are wanting to participate in a faster-growing economy, then it's dividend growth that is all the rage, and people tend to forget about current yield. When you start talking about, say, a 15%, 20%, 30% dividend increase from a company, that's great. But if the stock still only yields 1% or 2%, I think you need a little richer mix of income within that.

Glaser: You mentioned that dividend-growth investing is very much in fashion now. How is that generally defined? What does it mean if someone says they're pursuing a dividend-growth strategy?

Peters: I think in the consciousness of the market, the way I get a sense of what dividend-growth investing is in the collective mind of the market, it's got less emphasis on current yield. Very often you find dividend-growth investors looking for yields that are no better than the market average around 2%, or sometimes less than 2%. Instead, what you're looking for are either companies that have very high rates of dividend growth, 15% or 20% a year or more over some extended period of time. Obviously, there are some questions about how long any kind of growth rate like that can be sustained.

[Or the second thing you're looking for are] companies that have shown very consistent records of dividend increases in the past. Mergent maintains a very popular list called its Dividend Achievers list. A company has to have raised its dividend without interruption for 10 straight years or more to make it into the Dividend Achiever category. There's a very large, very popular exchange-traded fund that's based on that approach, called Vanguard Dividend Appreciation, ticker symbol is VIG.

Standard & Poor's also has a list called Dividend Aristocrats, which requires 20 or 25 years [of dividend increases] to make it onto that list. So certainly you are getting something different from these kinds of companies in terms of quality compared with just the run-of-the-mill dividend-paying stock.

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