METHODOLOGY
For millennia our minds have been structured such that:
- 75 per cent of our neural connections are devoted to recognising potential dangers — meaning we are constantly searching for something to worry about. Why?
- In days of yore, our remote ancestors were always on alert, confronted with what evolutionary psychologists call ‘immediate return’ challenges, i.e., constant stimuli that required an immediate response and in turn generated an immediate effect on their survival prospects.
This is relevant because any focus on moving prices as a measure of performance (such as stocks in general or the S&P500 in particular) will always be vulnerable to interpretation as a possible danger signal, requiring immediate action – like exiting – in response.
It’s why most investors find stocks or the S&P500 – which generate constant, random price stimuli – so hard to hold or succeed with. In the absence of a meaningful, alternative methodology, this is unlikely to change.
This is something advertising mavens David Ogilvy and his contemporary Bill Bernbach understood, and so we look to them for inspiration. In their view, human nature has been fundamentally unchanged for a million years. So, looking forward, both argued any better solution (or product or service) and its communication needs to be “concerned with the unchanging man — what compulsions drive him, what instincts dominate his every action.”
So, what if we adjusted the focus away from the S&P500’s moving prices as a measure of performance?
In the late 1950s, a trio of famous professors at MIT demonstrated that dividend-paying stocks as a group outperformed non-dividend-paying stocks. They also showed that companies which raised their dividends faster outperformed the base dividend-paying group.
This was articulated in the now universally accepted Gordon Growth Formula. It shows that over time, and at points in time, the rate of growth in the dividend will be replicated by a roughly equivalent rate of growth in the share value. Because dividend growth encapsulates and reflects a company’s real intrinsic growth, it is unsurprising that over time, a company’s share price will also mirror this underlying internal business growth. For many investors — especially those with a real-estate background — this is intuitively obvious, i.e., when the rent goes up, the value increase follows. Indeed, for most assets, when the cash income increases, the asset value increases — perhaps not immediately, but in time and with high predictive certainty.
While the Gordon formula is straightforward, there is a caveat: it breaks down if the sequence of dividend growth is interrupted.
DivGro, a Sydney-based investment boutique, further identified that if:
- You could identify those uninterrupted dividend growers — which is a non-trivial task, especially if one is looking for relatively fast dividend-growers (DivGro has produced a real-time sequence of 167 dividend increases, with an average increase rate of about 14.83 per cent over the last five years); and if
- The Gordon Formula held (which has been demonstrated empirically over many decades); and if
- You on-paid to and encouraged investors to see those receipts in their bank accounts; and if
- You communicated this dividend growth progress actively, systemically, and understandably, then:
1) The Gordon Formula can be inverted to enable investors to focus exclusively on dividend progress as their arbiter of success, and
2) By implementing a Pavlovian feedback loop, investors can be positively coached to watch and want their dividends and dividend growth even more than they wish to expose themselves to the temptations, vagaries and mental anguish of constant and random price behaviour.
This inversion would more closely resemble pre-stock exchange behaviour. Back then, investors owned pieces of businesses — the better businesses paid and regularly increased their dividends — which were used in part to live off, and which became the primary or even sole variable investors were concerned with. Characteristically, owners passed down their increasingly valuable ownerships to their next generations.
Today, in practice, focusing exclusively on dividend growth is akin to trying to win any proverbial ball game by focusing on the ball, rather than the scoreboard.
DivGro has delivered an effective proof of concept. Since 2019, DivGro has implemented its dividend growth-focused approach for more than 100 investor families, coupled with its easily understandable dividend progress communications delivered to more than 600 weekly recipients. The response from this group has been that although investors may hold the same stocks elsewhere, differentially, in the uniquely understandable, positive and holistic DivGro format, they become easier to hold.
This is unsurprising given this model is rooted in human behaviour. While people can seldom come to terms with price randomness, a superior dividend grower provides relatively high visibility into its dividend trajectory. Overlaid with frequent, meaningful and straightforward communications — together with the quarterly dividend receipt in cash — this format facilitates deliverable and reliable patterns to develop in our minds, which is precisely what the human mind is naturally predisposed to do.
By combining the Gordon Formula with an exclusively upwards dividend progression, a believer in this system can legitimately picture themselves as benefiting or winning every day — a feeling reminiscent of Warren Buffett’s advice that investors should aim to make money while asleep, otherwise you will have to work forever.
Another fundamental benefit of superior dividend growers, coupled with active communication, is that these break the so-called ‘long-run’ investors are routinely encouraged to look to (but can seldom visualise) into a much shorter, more easily attainable series of ‘short-runs’. Superior dividend growers follow a relatively predictable quarterly cycle: within a 90-day window they typically (1) declare their dividend, then (2) shareholders become entitled to that dividend (the stock goes “ex”), and then later (3) the dividend is paid to stockholders. Often, during the fourth quarter in a cycle, a dividend raise will be announced for payment in the next (or fifth quarter), and so the dividend flywheel continues, often for many years.
It was Alfred Adler’s insights which demonstrated that since we live in and experience a subjective world, we should review and reinterpret what we see, as we see fit, if that works better for us. There is no reason preventing investors from using a different lens to view the investment process, should that approach create a better investor experience. By recalibrating the ‘long-run’ into a manageable series of ‘short-runs’, the same stocks or portfolio become easier to hold, as one envisions oneself benefiting or winning every day as the current dividend is paid and the next dividend date draws nearer. This approach powerfully aligns with fundamental human behaviour and recognises that our need to focus on something is innate, but not predetermined — so, as per Adler, we can harness (rather than be hindered by) our fixation so that it works for us, not against us.
While the dividend growth theory is solid, and a keen hand is needed to continue to identify the faster and more reliable dividend increasers, it is the proactive, continuous engagement and positive messaging which roots investors within the process, enabling them to feel, experience and ultimately master the art and benefit which accrue to the genuine dividend growth investor.
Effectively, these adjustments make the investment pathway more manageable, more understandable and more predictable for investors, making a positive outcome more likely to materialise. A higher likelihood of a good result provides higher utility for most investors than the lofty promise or hope of the highest possible score, riddled by a cumbersome, exhausting and unpredictable pathway.
Fortunately, the S&P500 hosts many companies which are excellent dividend growers. By actively highlighting these, in tandem with proactive and proven engagement, it should be entirely feasible to migrate investors away from a hard-to-endure, moment-to-moment S&P500 rollercoaster-like experience, towards a more palatable experiential journey.
Furthermore, the S&P500 has two further, significant attributes with genuine predictability (which feed into our need and love for familiar, understandable and recognisable patterns), namely:
1. A holder can be certain of not doing worse than the primary averages, and
2. The index (unlike a great many individual stocks) has always regained and exceeded its previous highs
By overlaying a classic dividend growth approach onto a core S&P500 holding, Force500 extends the reinforcement instilled by DivGro’s dynamic ecosystem (a twofold focus on dividend growers and active engagement) onto a holder — from novice to institutional — who seeks to closely track the S&P500’s underlying performance but due to all known limitations struggles to do so.
To this effect, Force500 recalibrates the ratio of its S&P500 allocation with a higher or lower classic dividend growth component, depending on whether it perceives a greater need for tracking or reinforcement. Accordingly, the S&P500 allocation will vary between a minimum of 2/3 to a maximum of 115 per cent, while the classic dividend growth allocation will vary between a maximum of 1/3 to a minimum of five per cent.