Ten FTSE 350 stocks for dividend growth investors

The late American investor Philip Fisher once said that regularity and dependability are the most important but least discussed aspects of dividends. He reckoned that high yield was actually less important than companies with consistent, progressive dividend policies. And he wasn't the only one. A long history of research shows that progressive dividend growth is not only a signal of confidence but it can also produce some of the best long-term returns.

Fisher was famed as a growth stock investor who influenced the thinking of Warren Buffett. In his book Common Stocks and Uncommon Profits, he wrote: “The managements whose dividend policies win the widest approval among discerning investors are those who hold that a dividend should be raised with the greatest caution and only when there is great probability that it can be maintained."

Fear of dividend cuts

Fisher published his book in 1958, shortly after an influential research paper into dividends was produced by Harvard finance professor John Lintner. Lintner's study found that many company executives believe the market puts a premium on dividend stability and gradual growth. They fear the ramifications of cutting dividends - so they only raise payouts when they're sure that future earnings can support them.

Fast-forward nearly 50 years and research by US fund managers Rob Arnott and Cliff Asness arrived at similar conclusions. They studied whether companies that reinvest cash and pay low dividends eventually generate the strongest earnings growth, as many investors assume. But their research found the opposite. It drew a link between proportionately high dividends and high earnings growth. One of their proposed reasons for this echoed Lintner's earlier observation that management teams generally only hike payouts when they're optimistic about the future.

Screening for dividend growth

At Stockopedia we track a long-term dividend growth strategy called Dividend Achievers. It's loosely based on the Nasdaq operated Dividend Achievers Index. Over the past year it has generated an 18.8% return (before dividends). To focus on FTSE 350, we duplicated that screen with the following rules:

• FTSE 350 companies with dividends that are forecast to grow next year.
• Dividend growth streak of more than 4 years.
• Earnings that have grown by more than 10% compounded annually over the past 5 years.

We included the Quality Rank, with scores and ranks every company in the market using measures of profitability, financial strength and low risk -- from zero (low quality) to 100 (high quality). The overall list is sorted for rolling yield. Stockopedia subscribers can see the screen here.

The yields on offer range from 4.2% at fund manager Aberdeen Asset Management to 3.1% at housebuilder Bellway. Interestingly, Bellway has by far the highest forecast dividend increase for 2015, at 36.4%, which would give a dividend per share of around 70.9p. Bellway is a conviction holding in Mark Slater's MFM Slater Growth Fund, which we reported on here.

Aberdeen, Imperial Tobacco and BAE Systems have the longest dividend growth streaks, at 9 years apiece.  Online trading specialist IG Group has the highest Quality Rank here, at 99 out of 100. That's partly driven by a consistently impressive track record of profitability and financial strength. In terms of earnings growth, technology company Laird boasts the strongest 5-year CAGR at 30.3%. That's followed by Aberdeen on 29.8% - although it's worth noting the firm has recently reported higher outflows from its funds.

A signal of safety

One of the interesting things about the dividend growth streak is that it can serve a dual purpose. On one hand it can give income investors a picture of how sustainable a dividend is and whether the payout might be at risk. On the other, the dividend streak can give growth stock investors - like Philip Fisher - an indication of the confidence of a management team and whether they expect earnings to grow in the future. Dividends, of course, can be cut at very short notice when things go wrong with a company, so careful research is needed. But in the search for dividend safety and earnings growth, a strong track record could be a useful place to start.  

To find out more about dividend investing, you can download our ebook How to Make Money in Dividend Stocks here.