David Bahnsen David Bahnsen.

Here’s food for thought about what’s been fair game for ardent fans and passionate detractors alike: Buy the dividend to get the stock.

For at least one wholehearted devotee, it’s the basis of an all-weather investing philosophy that captures a “double miracle” of compounding, makes volatility “your friend” and is, all in all, the smartest way to gain equity return. So argues dividend-growth investing expert David Bahnsen in an interview with ThinkAdvisor.

What Bahnsen, 45, founder and managing partner of The Bahnsen Group, craves most about dividend-growth investing is the ability to meet clients’ cash-flow needs now and into the future.

Dividend growers are especially advantageous for accumulating and distributing retirement income: The investments are a hedge against inflation, mitigate risk, outperform the market with less volatility and perform well in periods of market distress, the FA maintains.

In his new book, “The Case for Dividend Growth: Investing in a Post-Crisis World” (Post Hill Press-April 2019), Bahnsen, named by Barron’s, Forbes and The Financial Times a top U.S. financial advisor, presents a compelling guide to everything you always wanted to know about dividend-growth investing — plus everything else.

The approach is focused on discerning those companies with a defensive business model and free cash flow that grow through profits and consistently grow the dividend they pay to shareholders. Such shining examples Bahnsen sites include McDonald’s, Procter & Gamble and Walmart.

In the interview, the advisor, whose firm manages $1.6 billion of clients’ assets, distinguishes between mere dividend payers and dividend growers. Further, he reveals the biggest positions of dividend-growing stocks in his firm’s portfolio.

The chief investment officer looks for stocks that have demonstrated dividend growth of 5% or more for at least the last five years.

In the interview, he makes a persuasive case for advisors to look into dividend-growth investing, or what he calls his “worldview,” because, he contends, it provides plenty of upside, companies with a defensive balance sheet and generates tax-efficient income with a better defensive downside approach.

ThinkAdvisor recently interviewed Bahnsen, whose firm, registered with HighTower Advisors, is located in Newport Beach, Caifornia, and New York City. The FA, who was previously with Morgan Stanley and UBS Financial Services, was speaking by phone from his Midtown Manhattan office. He is a frequent speaker on a range of topics, among them, “economics and liberty” and “Christians in the marketplace.”  In the interview, he explained how dividend-growth investing is not just a strategy but rather, a philosophy; and he did not hesitate to underscore that being good at it “takes work.”

Here are excerpts from our conversation:

THINKADVISOR: Is investing in dividend-growing stocks appropriate for retirement planning?

DAVID BAHNSEN: They’re fantastic both for people in retirement and for those who won’t retire for 30 years. They’re a great way to acquire capital that will be a future source of income, and they’re also a great way to protect income in retirement. Last December the market dropped 14% from peak to trough. But dividend-growth payers, like Verizon, McDonald’s, Procter & Gamble, Merck and Coca-Cola were down 4%, not 14%.

What’s the key difference between dividend growers and dividend payers?

Dividend growers are characterized by the consistent and repeatable growth of the income they’re generating, whereas a mere dividend payer doesn’t necessarily tell you anything about the company’s commitment to growth. There’s a third category too: high-yield dividend stocks. They’re dividend growers that pay a very high dividend, but they’re often future dividend cutters and not in a financial position to grow the dividend.

Why are dividend-growing stocks good to own during periods of market volatility?

They mitigate risk because you’re investing in strong companies with defensive characteristics. The price volatility that scares so many investors is muted relative to overall market volatility. Also, they benefit investors who are accumulating because the dividends are reinvested at lower prices.

Anything else?

Volatility becomes your friend: You get built-in compounding. With a dividend, you get compounding on the stock price and compounding on the extra shares at lower prices that you’re picking up from the dividend. You want some of these dividends paying out at lower prices. It lowers your cost of ownership over time.

Is investing in dividend growers more popular now?

Yes, but not in the right way: A lot of people talk about dividends because interest rates have been so darn low for so long, and they view it as just a way to beef up income. But this is an all-weather philosophy: I don’t believe in dividend growth because the Fed has interest rates low. I believe in dividend growth all the time, even in a higher rate environment.

What’s your central argument about dividend-growing stocks?

I’m [rejecting] the idea that they inherently underperform because they pay a dividend and are [therefore] less attractive, more boring, less growthy. The fact is that the dividend growers have substantially outperformed the entire market and have done so with significantly less volatility. The longer window you give yourself, the truer that is.

Why have these stocks been such good performers?

They have a balance sheet that’s more defensive, more reliable and has more equity and less debt. They have free cash flow generation and are generally less cyclical: They’re not relying on one product or one season to generate their earnings. Because of these conditions, the dividend is sustainable.

There are companies whose dividends “point to their greatness,” you write. Examples?

McDonald’s, which has proven to be one of the great performers of the last 30 years; Procter & Gamble; Walmart; Coca-Cola. For decades, year after year, they’ve been able to protect their free cash flow and continue to grow over time, which is hard to do. These companies [among others] have grown their dividend in good times and bad times — recessions, wars [etc.]. Perpetually growing, sustainable dividends point to a business strategy that’s clearly superior to their competitors.

Which stocks are the biggest positions in your portfolio?

Blackstone is our largest holding. The asset manager is paying roughly a 7% dividend, and they’ve grown it year after year for the last 10 years. We’re also very committed to Chevron, which has proven to be very committed to their shareholders. McDonald’s has been unbelievable! If you bought the stock in the early 1990s and then reinvested the dividend all these years, today it’s higher than the amount you paid for the stock 30 years ago. We also hold Procter & Gamble, Coca-Cola and Walmart. And we’re a huge holder of the gold standard of MLPs [master limited partnerships], Enterprise Products Partners.

Can dividend-growth investing focus on whole sectors of the market?

We’re less concerned with the sector and more concerned with the company.

But are more dividend growers found in some sectors vs. others?

I suppose that’s true at a [certain] point in time, but it isn’t true that it stays that way. It used to be there were no dividend growers in tech. Now some of the best dividend growers are in tech. It used to be that there were [many] dividend growers in consumer staples. Now a lot of consumer staples [have moved] away from that. So you have to approach this [way of] investing bottom up, company by company.

What’s another advantage of dividend growers?  

You can keep up with inflation when you invest in them.

Income investors say they want safety, so they go into fixed income. But they can’t keep up with inflation because their income is fixed: The bond coupon isn’t going to move. But with dividend growers, not only do you get the benefit of rising income but also the benefit of the companies passing on the impact of inflation to their customers. That’s what’s so profound about dividend growth.

Please elaborate.

The Procter & Gambles and Walmarts of the world have the ability to soften the impact of inflation because they’re passing it on to their customers. Their revenues are growing in nominal dollars, and they’re passing on a dividend to shareholders that’s growing in nominal dollars that’s above the rate of inflation.

You write that dividend growing stocks aren’t the hot stocks everyone’s talking about. Why is that?

Dividend growers are in the more financially mature cycle of their existence. They’ve probably gone through the brand new stage, the venture capital stage, the private equity stage. For example, Procter & Gamble still creates new products and acquires new companies to fit in their brand portfolio, but they’re mature enough to sustain a continually growing dividend off their legacy business.

A frequent criticism of dividend growing stocks is that companies can cut dividends. Such was the case with General Electric at the end of last year. How do you buck that?

Work has to be done to avoid those companies, and we work tirelessly to make sure of that. Therefore, a person who’s prone to being a passive index investor wouldn’t like investing in dividend growers because it can’t be done without a lot of work.

What are the main differences between investing in dividend growers vs. investing in companies buying back shares of their own stock?

Dividends are more advantageous to shareholders because they monetize the investment: They’re giving you a reward as opposed to a buyback, which just re-ups your risk in the investment. But most importantly, the company doesn’t have to do the buyback: They can announce it and authorize it, but you don’t ever get to know if they did it until after the fact. [In contrast], a dividend is declared and payable — and you receive cash. They can’t take cash away from you.

What else characterizes buybacks?

At least 70% are used for employee and executive compensation. So they have the potential to be done for the wrong reasons. That’s not as shareholder friendly as we would like.