High-Quality Dividend Growth Stocks Are Set to Massively Outperform

Fear is gripping the market right now.

First, a soft jobs report hit on Friday, showing U.S. unemployment ticked up to 4.3%…

Then, over the weekend, global currency traders aggressively unwound their Japanese yen trades…

Many are worried that this new weaker trend is forecasting doom and gloom for the economy. Not to mention that Iran and Hezbollah might both be on the verge of attacking Israel.

Seeing all this, traders are selling stocks with abandon. Apple (AAPL), in particular, is down hard amid news that “the Oracle of Omaha,” Warren Buffett, sold 49% of his shares.

As I write this, the S&P 500 is down 5% since Thursday’s close, and the tech-heavy NASDAQ Composite is down 6%.

Yuck.

How quickly narratives can shift. Just a handful of days ago, the media was as bullish as you could be… today, most are fearing the worst.

But here’s the deal…

Fear is NOT a strategy.

Getting emotional when volatility strikes is a wonderful way to lose a lot of money… fast!

Instead of worrying about things out of your control, you should be looking for the types of stocks and companies that can actually outperform when the going gets tough.

I’m talking about high-quality dividend growth stocks.

And before you fall asleep, trust me, this is one area that not only can buffer your portfolio in times of distress… it also can build your wealth massively.

Today, instead of dwelling on the what-ifs of global economies, we’re going to take a stroll through history and learn about the power of dividend-growth investing.

We’ll note the ballast it offers when stocks get tossed around by the winds of fortune… and I’ll also showcase a rockstar company worthy of your watchlist.

Dividends are Responsible for 40% of Stock Market Returns
Before we dive into the tactical reason to own top-shelf dividend stocks right now, let’s first unpack what a dividend is.

Dividends are basically a share of profits that a company pays its shareholders. Typically, it’s the well-established and well-run firms that deploy their cash in this way. Many of the biggest brands on the planet routinely offer payouts to their stockholders (more on this in a bit).

And dividends are not just a “steady eddy” strategy for conservative investors. They can be a serious wealth builder.

In fact, 41% of the S&P 500’s long-term returns come from dividends.

Below shows this beautifully. Here we can see the total returns for the S&P 500 by decade. You’ll see in blue the price return, and in green is the dividend return. Average them all out and nearly half of the market gains are due to the power of dividends:

So, neglecting dividends is very bad for your long-term investing success. Just look at how stocks would have fared without them in the 2000s, for example.

Now let’s take it a step further and learn why today’s high-volatility environment creates another case to own yielding stocks.

Trying Times are Dividend-Buying Times
Without question, volatility, or uncertainty, has spiked to the highest levels of the year.

The CBOE Volatility Index (VIX), which tracks the premiums paid for S&P 500 put and call options, has ripped to 65 at one point on Monday morning. (When these premiums rise, it represents how much traders are willing to pay for portfolio protection.)

That’s the highest level since March 2023 and towers above all levels the past year:

Given Wall Street’s fear gauge is on high alert, should you duck and run?

ABSOLUTELY NOT! Over the long term, you should keep a calm head and ride it out… especially with dividend growth stocks.

But don’t take my word for it. Let’s study history.

Since 1990, the worse volatility gets, the more dividend stocks outperform non-payers.

Below reveals that when the VIX increases on a monthly basis, dividend growers outperform non-dividend payers by 1.06% on average.

When the VIX climbs over 20%, dividend growth stocks outperform by more than 2.06%:

2% might not sound like much. But think about how remarkably consistent this is.

Every time volatility rocked the market over a 32-year period, the slow, boring, value-rich companies that nobody wanted in a raging bull market suddenly become the safe haven.

They fall less on the way down and rise more on the way up. That’s where you want to be in times like this.

Yielding stocks can anchor your portfolio when skies get stormy.

So, which kinds of dividend growth names should you focus on?

Your best bet is to identify the best-of-breed companies that dominate their space with a rich history of dividend growth.

Bellwether retailers Walmart (WMT) and Home Depot (HD) are prime examples of companies with long histories of rewarding shareholders with growing payouts year after year. (Disclosure, I’ve owned both for years.)

At last measure, Walmart offers a 1.2% yield on its shares, whereas Home Depot has a beefy 2.5% yield.

Let’s zero in on the latter. While it’s a short time frame, HD has been outperforming the S&P 500 over the past month by a wide margin.

This doesn’t surprise me one bit:

Now that we understand the role that dividends play in a portfolio when times get rocky, let’s hammer home why you want to nail down similar companies with Home Depot-style profiles…

Why HD Is a Dividend-Growth Superstar
Let’s roll back the tape to February when I made the case to own dividend growth stocks and showcased HD’s stunning stair-step annual dividend payments.

As you can see, like clockwork, investors who have owned shares of HD have continuously enjoyed income pay raises. In 2024, HD will hand out $9 for every share owned:

Investing in dividend growth stocks over the long term is the holy grail of investing. Very few strategies can match the compounding wealth effect.

This is the dynamic you want to see.

Now, it may be tempting to say: “Why settle for 2.5%?” and buy into the highest-yielding stocks as interest rates fall. But those high yields come with equally high risk… and you’ll be left holding the bag when those companies cut their yields.

Instead, chase the highest-quality businesses with years of historical dividend raises.

Using TradeSmith’s Business Quality Score (BQS), you’re able to see a grade for four powerful metrics: Profitability, Safety, Growth, and Payout.

Energy Transfer LP (ET), for example, is an oil & gas pipeline company that pays nearly 8% forward dividends but falls short on business quality – particularly Profitability and Payout:

Meanwhile, Home Depot gets an A. While ET earned a Business Quality Score of just 40… HD gets a 94:

Look, if you’re worried about the economy or Federal Reserve policy, trust in stable businesses with a track record of success.

Use all-star software like TradeSmith to weed out the winners.

That’s a recipe that pays dividends!

Regards,

Lucas Downey
Contributing Editor, TradeSmith Daily

Source: Trade Smith