Dividend Growth Investing Done Right

A guide for this popular investment style

In the investing universe, there is a (sterile) war that everybody has heard of: are dividends good or not?

On one side, dividend skeptics argue that capital appreciation is the key priority, that reinvestment beats distribution, and that a company paying dividends is a company out of ideas. They also add that dividends do not actually make shareholders richer, since the payout is offset by a drop in the stock price. The company pays with cash, reducing its assets: it is a zero-sum game in terms of net worth. On the other side, dividend loyalists point to the stability, discipline, and income-generating potential of regular payouts.

But beyond this binary debate lies a more nuanced and powerful strategy: dividend growth investing. It is not about high yields or chasing income. It is about owning businesses that reliably grow their dividends year after year, creating a rising stream of cash flow that compounds over time. It also allows to chase for the best business models.

Let’s break down what makes dividend growth investing so compelling and why it is a valid investment strategy.

What is dividend growth investing?

Dividend growth investing focuses on stocks that consistently increase their dividends over time. These are often profitable businesses with strong balance sheets, predictable cash flows, and shareholder-friendly capital allocation policies (often including share buybacks).

Rather than seeking the highest current dividend yields, investors in this strategy prioritize dividend sustainability, long-term growth potential and… business quality which is why I find it is a decent investment strategy.

This approach creates a virtuous cycle of compounding.

Why it is a decent investment strategy

The main advantage of dividend growth investing is not just financial, it is psychological. Surprising? Maybe. But as I have discussed earlier in this article, one of the biggest threats to investor success is a holding period that is too short.

Dividend growth investing combats this. By delivering a tangible, growing stream of income, it gives investors a clear signal of progress, even when stock prices are volatile or flat. Watching your annual dividend income increase year after year offers a powerful sense of forward momentum. It reassures you that your portfolio is doing its job, even when markets are not.

This reinforces good investing behavior. Rather than panic-selling in a downturn, you are more likely to stay the course, keep reinvesting, and let your capital compound over time. In this way, dividend growth provides not just cash flow, but clarity and conviction.

And the advantages do not end with mindset. Dividend growth investing brings a suite of long-term financial benefits:

• Total return enhancement. You benefit from both capital appreciation and a rising stream of dividends. A consistently increasing dividend is often a sign of a healthy, quality business.

• Volatility buffer. Historically, companies that consistently grow dividends tend to experience smaller drawdowns during market corrections. Investors often view them as safer holdings.

• Behavioral reinforcement. As I exlained receiving regular, growing income makes it easier to stay invested during downturns, reducing emotional decisions that can sabotage long-term performance.

2 common traps: chasing for yield and relying on the past performance

Two traps frequently seen as dividend investors: chasing high yields and relying too heavily on past performance. The allure of a stock offering a ultra-high yields can be tempting, but elevated yields often (not always though) signal underlying risks (deteriorating business model, unsustainable payout, …). In many cases, a high yield is a warning sign, not a gift.

Equally dangerous is the assumption that a company’s past dividend growth guarantees future results. Just because a firm has raised its dividend for 10 or 20 consecutive years doesn’t mean it will continue to do so if fundamentals weaken. Smart dividend growth investing requires a forward-looking approach: assessing payout sustainability, business quality, earnings trends, and capital allocation discipline. Avoiding these two traps is essential to building a portfolio that compounds reliably over time.

That is why I use my classic total shareholder return approach to identify potential candidates.

How to Estimate the Total Shareholder Return?

In simple terms, you want companies with the following characteristics:

• Sustainable long-term future growth

• Reasonable valuation

• A consistently growing decent yield

How to pick your dividend growth stocks

The stock selection process for dividend growth investing is not radically different from classic equity investing. It still begins with a focus on growth and quality (strong fundemantal, consistent revenue and earnings growth, expanding margins, clear competitive edge, …). On the dividend side, key metrics include the starting yield, payout ratio (ideally moderate, to allow for future increases), a track record of dividend growth, and a reasonable projection of future increases based on earnings potential.

It is also important to build a balanced portfolio, diversified across sectors and geographies. This helps mitigate the risk of relying too heavily on a single industry’s dividend outlook.

For those preferring a more hands-off approach, dividend growth ETFs are a solid option. Popular choices include VIG (Vanguard Dividend Appreciation ETF) and SCHD (Schwab U.S. Dividend Equity ETF). While these funds offer convenience and diversification, it is worth noting even if yields are decent, the dividend growth may lag more curated individual stock portfolios. Still, they offer an easy way for dividend growth investing.

In an upcoming article, I will share a handpicked selection of high-quality dividend growth stocks worth watching, so stay tuned!

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What are your views on dividend growth investing? Drop your take in the comments