Wealth Creation & Growing Dividends

April 7, 2015

One of the benefits of dividend investing is that dividends can grow over time. Dividend growth is a key objective of the Guinness Atkinson Dividend Builder Fund. In fact, we push this objective further: we seek to have the Fund grow its dividend at a pace that exceeds the inflation rate.  This objective is a distinguishing factor of the Fund’s income strategy, and it is important to many investors. The key to this strategy is investing in high quality companies that consistently create wealth. But how, exactly, do we identify high quality companies?

We start with the recognition that the dividend is the end product—the result of wealth creation. Without wealth creation there can be no sustained and growing dividend.  In our search for high quality companies, we’re looking for companies that have consistently demonstrated a well above average return on capital. We have identified quality companies by systematically looking for companies that have produced a 10% cash flow return on investment (CFROI) over each of the last 10 years. This is a very, very selective screen; in any given year about one in four companies has achieved a 10% CFROI.  But well less than 3% have been able to achieve this wealth creation for 10 consecutive years. These high quality companies can be found in almost all industry sectors, suggesting that our screen for high quality is identifying the best of breed companies that have demonstrated some sort of competitive advantage that has permitted them to earn consistently high returns on capital. This competitive advantage could be some sort of intellectual property or superior management or maybe a valuable brand.

We have found that consistent, above average wealth creation is a better indication of the ability to raise dividends than simply a history of rising dividends. That last sentence might seem a bit confusing. The point is that a history of rising dividends, often used as a method of selecting dividend building stocks, doesn’t offer the same ability to identify dividend growers as identifying quality companies that achieve a high level of return on capital consistently over a long period of time. This is because it is quite possible for a company to increase its dividend payment even in the face of deteriorating business conditions. In fact, dividend aristocrats will often do just that to maintain their status as dividend aristocrats.

Two well-known companies, Kmart and Eastman Kodak, were once considered blue chip dividend payers. Both of these companies continued to increase their dividend despite declining business fortunes. Investors looking at just the history of dividends without looking at the quality of the underlying business may have well missed the coming dividend cuts and indeed the decline of these once great companies.

We require 10 years of consecutive high rates of return on capital for a reason: most business cycles are less than 10 years and we’re looking for companies that can demonstrate their competitive advantage through the good and bad portions of a business cycle. Maintaining profitability throughout business cycles has also been a good indicator of the potential sustainability of the dividend and dividend growth.  

So what types of companies do we find that are able to meet the strict criteria to be considered high quality?  Many of the companies that meet our definition are the obvious dividend payers, companies like Coca-Cola, Wal-Mart and Microsoft. But many others might be considered unexpected, companies like Schneider Electric, Aberdeen Asset Management and L-3 Communications.

Some of the companies we identify as high quality will be trading at a value that we might find too dear. We are value biased investors and seek to invest in a portfolio of high quality companies at reasonable prices.  In short, we’re looking to invest in these high quality companies at prices that might be more appropriate for average companies.

As our Dividend Builder Fund has just reached its 3 year mark, the question must be asked: How has this strategy done and how has the Fund performed?

In its Lipper Global Equity Income category, the Fund has become the top ranked fund in the three year time period out of 96 Funds, as of 3/31/15.  The Fund was ranked 43 of 143 for the one year time period.  These rankings are as of 3/31/15 and based on total returns with dividends and distributions reinvested. 

Fund Managers Dr. Ian Mortimer, CFA and Matthew Page, CFA


Click here to view the Dividend Builder Fund’s standardized performance.

Click here to view the Dividend Builder Fund’s top 10 holdings.

Fund holdings and/or sector allocations are subject to change at any time and are not recommendations to buy or sell any security.

Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice.

The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus and summary prospectus contains this and other important information about the investment company, and it may be obtained by calling 800.951.6566 or visiting gafunds.com. Read it carefully before investing.

Mutual Fund investing involves risk. Principal loss is possible. Investments in foreign securities involve greater volatility, political, economic and currency risks and differences in accounting methods. These risks are greater of emerging markets countries. Investments in derivatives involve risks different from, and in certain cases, greater than the risks presented by traditional investments. Investments in smaller companies involve additional risks such as limited liquidity and greater volatility.

Past performance does not guarantee future results.

Dividend Aristocrat- A company that has continuously increased the amount of dividends it pays to its shareholders. To be considered a dividend aristocrat, a company must typically have raised dividends for at least 25 years.

Return on Capital is a financial measure that quantifies how well a company generates cash flow relative to the capital it has invested in its business.

Cash Flow Return on Investment (CFROI) is a valuation model that assumes the stock market sets prices on cash flow, not on corporate earnings. It is determined by dividing a company’s gross cash flow by its gross investment.

CFROI is a proprietary metric prepared by HOLT, a division of Credit Suisse. CFROI is a registered trademark of Credit Suisse AG or its affiliates in the United States and other countries. For more information on HOLT, a corporate performance and valuation advisory service of Credit Suisse, please visit their website at https://www.credit-suisse.com/investment_banking/holt/en/index.jsp

Lipper Analytical Services, Inc. is an independent mutual fund research and rating service. Each Lipper average represents a universe of Funds with similar investment objectives. Rankings for the periods shown are based on Fund total returns with dividends and distributions reinvested and do not reflect sales charges.

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