Dividend growth investing is a powerful strategy for building wealth over time, but not all dividend-paying stocks are created equal.
To separate the winners from the rest, seasoned investors often rely on the Dividend Triangle. This simple yet effective framework helps identify companies with robust financial health and long-term growth potential, making it an essential tool for dividend investors.
What Is the Dividend Triangle?
The Dividend Triangle focuses on three critical metrics that reflect a company’s ability to sustain and grow its dividend over time:
- Revenue Growth indicates whether a company is increasing its sales year over year.A consistent upward trend shows the business is expanding, capturing market share, or successfully increasing the price of its products or services.
Without growing revenue, a company may struggle to generate the cash flow needed to support dividend increases.
- Earnings Per Share (EPS) Growth measures a company’s profitability.While revenue growth reflects the top-line expansion, EPS growth captures how efficiently the company turns sales into profits.
Companies with consistently rising EPS demonstrate strong operational performance, critical for maintaining and growing dividends.
- Dividend Growth is the third leg of the triangle.A company regularly increasing its dividend signals financial stability, strong cash flow, and a shareholder-friendly management team. For dividend investors, this is a sign of reliability and a hedge against inflation.
Together, these three metrics form the foundation of the Dividend Triangle, helping investors gauge a company’s overall health and its potential for long-term dividend growth.
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Why Is the Dividend Triangle Important?
Investing in dividend-paying stocks is about more than just yield.
High-yield stocks can sometimes mask underlying problems, such as poor growth prospects or excessive payout ratios. The Dividend Triangle provides a more holistic view, ensuring that the stocks you invest in not only pay dividends but have the financial strength to sustain and increase those payments.
For example, a company with strong revenue and EPS growth but stagnant dividends may signal an opportunity for future dividend increases.
Conversely, a company with flat or declining revenues but high dividends may be at risk of a future dividend cut.
How to Evaluate the Dividend Triangle
Let’s break down each metric in more detail to understand what to look for.
- Revenue Growth: Aim for companies with steady, consistent revenue growth over the past five years. Volatility in revenue may indicate a lack of stability in the company’s business model or exposure to cyclical market forces.
Example: A company like Apple has shown impressive revenue growth over the years, driven by product innovation and brand loyalty.
- EPS Growth: Look for a minimum of 5% annual growth in EPS over the past five years. This ensures that the company is growing its revenue and managing costs effectively.
Example: Microsoft is a prime example of a company with robust EPS growth, fueled by its shift to high-margin cloud services.
- Dividend Growth: Ideally, seek companies with a dividend growth rate of at least 5% annually. This ensures that your dividend income will keep up with or outpace inflation, preserving your purchasing power.
Example: Visa has consistently increased its dividend by double digits, reflecting its strong business model and growth prospects.
Real-Life Applications of the Dividend Triangle
Consider this scenario:
You’re deciding between two dividend-paying stocks.
- One offers a 6% yield but shows declining revenues and flat earnings.
- The other has a 2% yield but boasts consistent growth across all three legs of the Dividend Triangle.
While the first stock may look attractive for its high yield, it could lead to disappointment if the company cuts its dividend due to financial strain. Despite its lower yield, the second stock is far more likely to provide stable and growing income over the long term.
I have given more explanation about the misconceptions of low versus high-yield stocks in this article.
Limitations of the Dividend Triangle
The Dividend Triangle is a powerful tool, but it’s not foolproof.
Past performance doesn’t guarantee future results; even strong companies can face challenges. Always supplement your analysis with a deep dive into a company’s business model, competitive position, and industry trends.
Due to their unique financial structure, it also has limitations when applied to Real Estate Investment Trusts (REITs). You can adjust the Dividend Triangle for them. Instead of using the traditional metrics, consider these alternatives:
- Revenue Growth —> Same-Property NOI Growth & Occupancy Rate
- EPS Growth —> AFFO per Share Growth
- Dividend Growth —> AFFO Payout Ratio & Dividend Stability
The Dividend Triangle in Action: A Case Study
Let’s look at Alimentation Couche-Tard (ATD.TO), a leading convenience store operator.
Over the past decade, ATD has demonstrated impressive revenue and EPS growth, supported by strategic acquisitions and operational efficiencies. Its dividend, while modest in yield, has grown steadily at a high single-digit rate.
This strong Dividend Triangle has made ATD a favorite among dividend growth investors, delivering substantial returns over the years.
As you can see, ATD’s revenue and earnings are impacted by the economy. We see a weakening dividend triangle in 2024. Keep in mind this is only one year. Again, you must combine these numbers with the company’s business model, competitive position, and industry trends.
The company counts on multiple organic growth vectors such as Fresh Food Fast, pricing & promotion, assortment, cost optimization, and network development. ATD has a growth plan (10 for the win) to generate over $10B in EBTIDTA in 2028. This includes a mix of organic growth and acquisitions.
Given that and its impressive history and trends, I am willing to give ATD some time.
Conclusion: Building Your Portfolio with the Dividend Triangle
The Dividend Triangle is a simple yet effective framework for identifying high-quality dividend-paying stocks.
By focusing on revenue, EPS, and dividend growth, you can build a portfolio of companies with the financial strength to sustain and grow their dividends over time.
As a dividend growth investor, your goal isn’t just to earn passive income—it’s to create a reliable and growing income stream that stands the test of time.
The Dividend Triangle provides a proven roadmap for achieving this goal. So, the next time you evaluate a dividend stock, remember to look beyond the yield and consider the complete picture painted by the Dividend Triangle.
Why don’t you start now by downloading the Dividend Rock Stars List, built with companies showing a positive dividend triangle?
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