Shares with growth dividends protect against inflation

3 min read 6 Dec 22

Over my career, I have developed a strong investment strategy that has proved its to be resistant in different market conditions. The return of inflation has only underlined its relevance. 

Dividends are one of the most powerful engines of shares markets. The performance of firms who adopt a clear long-term policy in payments is usually outstanding. These statements reflect the convictions I have forged since 2008.

Fifteen years of practice

Since then, I have devoted my career to this issue of dividends to fully capitalise on it. And my convictions have stood the test of fifteen years of practice marked by many challenges and two crises in the financial markets: the 2008 financial crisis and the 2020–2021 pandemic.

In the face of inflation returning, this strategy could reveal its good results and protective qualities.

I am often asked, rightly, why it is relevant to focus on firms that pay dividends – because dividends do not increase shareholders’ assets, contrary to a preconceived idea. All else being equal, the price of a share should decrease in proportion to the coupon paid when it is clipped.

The main reason for this is that firms struggle to reinvest all their profits optimally and identify the right projects without ever making mistakes.

Keeping a tighter rein on spending

Over time, our opinion is that they become less disciplined. They make mistakes and become exposed to projects that do not pay well or even cause loss. This ends up putting their shareholders at a disadvantage. However, firms that pay dividends keep a tighter rein on their spending and chose projects more wisely.

Still, we prefer growth dividends to high dividends. High dividends can betray the woes of a struggling firm – one too bogged down in debt or going through a critical change. 

The average rate of dividends in our strategy is in a reasonable range of 3% to 4%. But we ensure they offer potential annual growth of 5% to 10%*.

I have always managed this strategy in a context of stability or falling consumer price indexes. But this strategy now seems to prove its worth with the return of inflation. I believe that only growth dividends can offer real positive yields. High dividends are tempting at first glance, but in my view, they are unable to grow so they do not protect against inflation.

Dividend growth

To ensure your assets do not decrease in value, you have to invest in good stocks, of course, but also in firms whose dividend growth rate is the same as, or exceeds, the rate of inflation.

Our approach should continue bearing fruit in coming years – provided the right stocks are chosen. That is the challenge we rise to.

To meet this challenge, a good starting point is to look in the rear-view mirror to identify boards that take dividend growth seriously.

Yet this policy has to be pursued going forward in the firms concerned. And we operate with this in mind, focusing on the firms we feel more promising in the next ten years.

A big pool

The US represents the biggest share of our investment universe, even though Wall Street is more associated with major growth stocks. Hundreds of US shares are eligible for our fund. A considerable pool is also available in Western Europe, Australia and Canada. And prospects are brightening up in Japan after some tough years.

We find firms that best meet our criteria in the most defensive sectors, especially in everyday consumer goods and health.

For more cyclical sectors, it is a bit harder to select stocks. I can nevertheless mention good firms like the Swiss group ABB or US companies like Analog Devices, Broadcom and KLA in semiconductors**.

*For illustrative purposes only. Target returns are not guaranteed.
**For illustrative purposes only. The information provided should not be considered a recommendation to purchase or sell any particular security.

By Stuart Rhodes

The value of a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Whenever performance is mentioned, past performance is not a guide to future performance.

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