The Right Price for Dividend Growth

02/17/2015 9:00 am EST

Focus: FOREX

Mark Salzinger

Editor and Publisher, The No-Load Fund Investor

With interest rates so low on high quality bonds, it’s understandable that many investors have been buying such high yielding equities as electric utilities and REITs, observes Mark Salzinger, editor of The No-Load Fund Investor.

Conventional mutual funds and exchange-traded funds that invest in such stocks have outpaced most other equity products over the past 12 months, driving their valuations to worrisome levels.

As a result, we believe that investors who can accept somewhat lower current payouts should consider dividend growth funds, the actual cash payouts of which should increase over time, and which offer superior potential for capital appreciation from current levels.

T. Rowe Price Dividend Growth (PRDGX) is one such fund with an excellent record of performance, even during difficult markets. More impressive, dividend growth has been able to beat the S&P 500 over the long run with less risk than the index.

Manager Tom Huber seeks out large, high-quality US stocks that pay dividends and have the wherewithal and managerial intent to increase them regularly over time.

For a company to sustain and even grow its dividend over the long run, it must have a high degree of durability, flexibility, and competitiveness.

According to Huber, a typical selection would exhibit revenue growth on the order of 4% to 5% per year, profit growth in the range of 7% to 8%, and a propensity toward returning cash to shareholders through share repurchases as well as dividends.

Were the valuation to remain constant, such a stock would be expected to produce a total return of approximately 10% per year.

While the fund is currently diversified across the market’s ten major sectors (with 115 holdings in total), it has much less than the market in technology stocks and less than the market share in energy stocks.

Instead, it has above-average exposure to healthcare, an economically defensive sector, and high-quality industrials, which are likely to perform well if the global economy grows more than most investors expect.

Huber is a long-term investor. The typical turnover in the fund is 15% to 20% a year, a very low level that suggests tax efficiency. Its low expense ratio—0.66%—also make it easy to own.

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