What makes Dividend Aristocrats a great investment for you?

From time to time, you can read about S&P 500 Dividend Aristocrats; these companies are members of the S&P 500 index that have paid and collected a dividend for at least 25 consecutive years.

Those looking for total income may scoff at dividend stocks as mature companies that have put their best growth days in the rearview mirror. But consider that the Dividend Aristocrats have collectively outperformed the S&P 500 by an average of 0.74% per year, which adds up to a significant margin over decades.

What’s the secret to their success and what does it mean for your wallet? Here’s why every investor should at least consider adding a few aristocrats to their long-term investment strategy.

Anatomy of a dividend

Most investors know what a dividend is: Companies that have cash on hand will sometimes share it with shareholders. But many investors skip the anatomy of a dividend and how it affects a business.

For example, a dividend is a cash outlay. Accounting rules can distort much of the financial jargon and metrics you see in a company’s finances. A company like Netflix may show a bottom line profit but generate little free cash flow at the same time because accounting rules can affect how companies report their earnings.

NFLX Net Income (TTM). Data from YCharts. TTM = after 12 months.

A company can only pay a cash dividend; it can borrow money to pay a dividend, but that’s a losing game that never lasts. A business that can not only pay you a portion of its profits in cash, but also keep increasing its annual payout, can only do so if it grows over the long term; you can’t fake it.

Successful investing can be as simple as buying quality businesses and letting them work their magic over time. A dividend aristocrat often fits that bill simply because of what is required of paying and raising a cash expense like a dividend.

An additional level of mixing

A steadily growing business will generate capital gains as profits grow over time, but it’s what you can do with the dividends that drives Aristocrats as an investment. Dividends are essential for investment returns; they accounted for 31% of the total returns from the S&P 500 from 1926 to 2021.

You can also reinvest dividends, taking the cash and buying more shares. These new shares cost you no money out of pocket beyond your initial investment and will pay dividends of their own, creating a compounding effect.

PG chart

PG data from YCharts.

This can have a significant impact on your total return on investment over time. Consider a stock like Procter & Gamble, a Dividend King with 66 consecutive years of dividend growth. Investors have earned a 4,720% lifetime return on capital appreciation since the early 1970s. That’s great, but that would have nearly tripled to 12,120% by reinvesting the dividends to take advantage of compounding!

You don’t need home runs to win the game

After all, you don’t need to find the other Amazon to have a profitable investment journey. Derek Jeter is one of baseball’s greatest players because he could consistently hit the ball year after year, even if he didn’t get out of the park very often.

The same goes for investing: A Dividend Aristocrat probably won’t make you rich overnight, but you can get rich by buying and holding Aristocrats as part of a diversified portfolio with a long-term perspective.

John Mackey, CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fool’s board of directors. Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions and recommends Amazon and Netflix. The Motley Fool has a disclosure policy.

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