You don't have to take big risks or bet on high-octane stocks to beat the market over the long haul. The best mutual funds know that owning a collection of blue-chip dividend stocks that boost their payout every year will often do the trick.
Buying so-called "dividend growers" and compounding wealth over time in a Steady-Eddie fashion is the winning strategy employed by Vanguard Dividend Growth (VDIGX).
This $53.2 billion actively managed dividend stocks fund is an IBD Best Mutual Funds 2023 winner. And its long-term record is stellar. Over the past 15 years, the 40 to 50 stock portfolio has posted an average annual return of 10.06%, topping 91% of its peers, according to Morningstar. In dollar terms, a $10,000 investment in the fund 15 years ago would now be worth about $42,115.
Top Dividend Stocks Mutual Fund
Vanguard Dividend Growth, currently comanaged by longtime pilot Donald Kilbride and Peter Fisher, will have a new look starting in 2024. As part of a succession plan, Kilbride is stepping aside. But he will continue to contribute ideas to the portfolio. Fisher has worked closely with Kilbride for more than a decade. Fisher was named co-manager in July 2022 and will assume lead manager duties.
The fund's wealth-building strategy takes advantage of the total return potential of quality companies committed to annual dividend hikes. But another key performance driver is the downside protection the fund provides when the market misbehaves. Losing less in bear markets is part of Vanguard Dividend Growth's appeal and success.
Last year, for example, when the S&P 500 tumbled more than 18% amid rising rates and skyrocketing inflation, Vanguard Dividend Growth fell less than 5%.
No Free Lunch With Dividends
But there's no free lunch in investing. The fund lags when the market-cap-weighted S&P 500 is in go-go mode and powered by skyrocketing growth stocks like Nvidia. So far in 2023, Vanguard Dividend Growth has eked a gain of less than 1%, which trails the S&P 500's 12% gain by a wide margin.
Still, despite lagging this year, a $100,000 investment in Vanguard Dividend Growth at the start of 2022 would be worth about $95,950 now, more than an estimated $91,840 for the broader market, thanks in large part to the more defensive fund losing a lot less in the 2022 market swoon.
IBD caught up with Kilbride and Fisher to learn how the fund's strategy can help investors build wealth and sleep well at night, too.
How This Top Dividend Stocks Fund Will Change
IBD: Will the fund's investment strategy change when Peter takes the reins?
Peter Fisher: There should be no change at all. Basically, the philosophy and process that I'll be following is exactly the same. Shareholders shouldn't really see any difference. We have a way of doing things that Don has created. We've been together for a long time. We'll keep doing exactly that.
IBD: Explain what a dividend growth strategy is, and how it differs from a high-yield dividend strategy?
Donald Kilbride: What we're going after is to try to deliver an investment vehicle which compounds wealth at a steady, predictable rate that over a long period of time is going to grow people's wealth in excess of inflation. An equity income strategy is more focused on current income and high yields, but that's not our approach. We don't really care much about current income. We're much more interested in the absolute growth of that underlying dividend over time.
IBD: What traits do you look for in a dividend-paying stock?
Kilbride: We're mostly interested in the dividend growth piece. We're looking for reliable, consistent compounding of value over time. A good dividend growth company starts with a consistent process of creating shareholder value. Spending money wisely on the company to make it better over time ... will show up in the share price.
Finding Top Dividend Stocks
IBD: Explain why you like companies that can pay dividends and are also committed to growing the payout.
Fisher: (Top-10 holding) Microsoft is the gold standard for what we're talking about. If you look back over history, Microsoft has had periods where it seemed like they were losing their way, but they've consistently added value to the enterprise.
The best example is their transition to the cloud. And that's clearly been reflected in the share price. Their willingness to pay a dividend is pretty obvious. And based on our estimates, Microsoft's dividend payout ratio (the percentage of earnings paid to shareholders via dividends) is below 30%, which is below the sweet spot. So, they've got plenty of room to grow the dividend that way if they choose to. But for now, they're not going to need to fiddle with that so much because the underlying earnings, free cash flow growth, and their constant march toward market share gains, particularly in the cloud, provide plenty of ammunition to pay and grow the dividend.
IBD: Any other examples?
Fisher: (The nation's largest health insurer) UnitedHealth Group is another. They have lots of (avenues) for growth. They really have been ahead of others in terms of anticipating where the industry was going. And more importantly, they are an enabler (in the fight) to cutting health care costs.
Why Dividends Pay Off Over Time
IBD: Serial dividend increasers tend to have defensible business models and staying power, right?
Fisher: The key thing is there needs to be something about that company, industry and business that gives them some defensible advantage that they can leverage over time. So, if you look through the companies in the portfolio, all of them do something or have some franchise, brand or industry structure that allows them to generate high returns on their invested capital over time. And one of the things that the market sometimes misses about these types of companies is that they can continue to do that year after year, decade after decade if they have the right franchise, the right market position. And maybe sometimes, people expect those advantages to go away much faster than they do.
IBD: Any examples?
Fisher: (Top-10 holding) McDonald's is a great example. They have restaurants and customers that have been around for a long time. They have the scale to invest in new things, new products, new technologies, as we've seen in the last few years. They've updated their stores and (digital customer engagement). And the advantage of their scale and size and customer base allows McDonald's to continue to deliver that advantage into the future. There are times when these kinds of companies sort of lose their way. Like a few years ago, when McDonald's brought in new management to reinvigorate the strength that they had. It wasn't a matter of changing the company so much. It's just going back to the things that made them great in the beginning and having a management team that was leveraging their strengths.
Top Mutual Fund Likes Moats
IBD: Morningstar says 75% of companies you own are wide-moat companies that can fend off competition.
Kilbride: A company with a wide moat is one that has one or two or maybe many things that really give them a meaningful advantage over their competition. It could be a patent. It could be a brand, (or) it could be a computer network. So, it's generally something that is incredibly important to the competitive positioning that isn't easily replicated. For example, it's really hard to challenge the Coca-Colas and the PepsiCos (two fund holdings) of the world.
IBD: Your fund isn't flashy and has big underweight in tech but still beats the market. How?
Kilbride: Yeah, this fund is not for speculators (looking to hit home runs). We hit a lot of singles and doubles (to use a baseball analogy). I don't even think there's a lot of triples. We're interested in compounding your wealth. Slowly. We provide value to (investors) by just being very, very reliable. I don't ever want a client to be surprised by what we're doing, what we're saying or what our results are.
Finding An Edge Over Time
IBD: So, what's the secret sauce to reap solid long-term returns?
Fisher: The secret to what we're doing is that we're really following the strategy of the tortoise. We're just plodding along. And investing in things that aren't that exciting. As human beings, we're always excited and attracted to the very big returns up and down. What we found is if we just focus on steadily compounding value in what some might say in a boring way, that will generate excess returns across the cycle. And because boring is not exciting, by definition, it's sometimes overlooked. And sometimes we're able to buy these companies (at attractive values).
IBD: Part of the strategy is not to lose lots of money in down markets, right?
Fisher: Losing money is the big enemy of compounding. If you lose half your money, it's not enough to be up 50% the next year. You have to double your return the next year to get back to even. So, if we can minimize the drawdown, that's part of the reason why this approach has worked so well over time.
Stocks Paying Dividends For Tough Times
IBD: So, investing in companies built-to-last pays off in tough times?
Fisher: We tend to do well in down markets because of our strategy. The kinds of companies we're behind tend to be pretty resilient to all sorts of downside risks, such as market sell-offs, cyclical risk, and recessions. So, when other companies find their businesses falling apart in bad times, the kinds of companies (we invest in) — a lot of consumer staples or health care names — continue to plug away. And we continue to buy those even in a recession. A lot of the companies we have in the portfolio sell products over and over again to all of us. They're repeat-purchase companies. All these things together mean that these types of companies are very resilient.
IBD: What sectors percolate up the most with your strategy?
Kilbride: We are not motivated by sectors. Having said that, the kinds of companies we tend to invest in create sector biases. Technology, as you mentioned earlier, is not a big area for us. Certain parts of it (such as software companies) are, but for the most part, we don't spend a ton of time there. We spend a lot of time with the consumer. We spend a lot of time in areas like industrials, transportation, defense, and staples on the consumer side.
Sticking To Dividend Sectors
IBD: Any sectors you pretty much avoid?
Kilbride: We don't own a lot of utilities, telecommunications, and industries like that which you'd find in an equity income portfolio. Those underlying businesses are either heavily regulated or don't grow. Banks are another group (we don't focus on) as they're heavily regulated and more volatile and more cyclical.
IBD: The fund has very low turnover and doesn't trade a lot. Why?
Fisher: We want to build value by compounding over time. And to do that we must own (the shares) long enough for that to happen. So, low turnover is integral to that approach. Other investors will make a lot of money by trading a lot. But our feeling is if we find the right companies that compound their value consistently, that will be the driver of shareholder return and we need to stick around long enough for that compounding to matter. So, we're very happy to own things for a very long time. And when we buy companies, we buy them with the expectation of holding them forever.
IBD: You don't pay up for stocks. What's the benefit of adding dividend growers at lower valuations?
Kilbride: Lower is better, always. And when it comes down to your returns, you want to get it as cheaply as you can. But more to the point, we buy something when there is dislocation in the market for whatever reason. We don't buy when you've got a lot of beta flying off the shelves. We want to buy when there's apathy, and where we can provide liquidity for companies that we all know intellectually are going to be around in 20 years. They are going to be great compounders of value and great dividend growers. (The stock weakness is) just a moment in time where people's attention is elsewhere.
Top Dividend Stocks To Hold Onto
IBD: Any examples of fund holdings you got during a downturn?
Fisher: Nike. Last year, there was a lot of issues around (rising) inventories, a lot of concerns about China, and that stock was just dislocated. And we were able to make the position bigger. And the year before defense contractors was an area where the stocks were really on sale. I think people had underestimated the global threat environment. And this was before, of course, we knew what was going to happen in Europe with Ukraine. We were able to add to a lot of defense positions a couple of years ago. The fund owns Northrop Grumman, Raytheon Technologies and Lockheed Martin.
