What are Dividend Aristocrats? Income investors should readily be able to answer this because buying dividend stocks is one thing, owning Dividend Aristocrats is another. If you're wondering why, consider that the S&P Dividend Aristocrats, as defined by the S&P 500 Dividend Aristocrats Index, are companies that have increased their dividends every year for the last 25 consecutive years or more. That's as safe as dividend stocks can get.

In this guide, we will cover the following:

What are Dividend Aristocrats?

Dividend Aristocrats are companies within the S&P 500 that have increased their dividends consecutively for 25 years or more. They stand out because they go beyond dividend yield and focus on dividend growth, backed by stable and steadily rising cash flows. The regular dividend increases, therefore, offer income investors a reliable and steady source of income, making Dividend Aristocrats a great tool to build wealth in the long run. There's evidence to back the argument: The S&P 500 Dividend Aristocrats Index generated 11.86% annually in total returns in the last 10 years versus the S&P 500's 9.17% annualized returns.

Safety, however, doesn't mean that Dividend Aristocrats will always raise dividends or never cut or suspend them. In fact, several stocks have dropped out of the S&P 500 Dividend Aristocrats Index over the years, either because they failed to increase dividends (note that the Index only considers regular dividend payments and not special ones) in a particular year or reduced or suspended them. Corporate actions like mergers, acquisitions, and spinoffs can also result in a stock being dropped from the index.

Plants growing on coins stacked beside each other to depict dividend growth stocks.

Dividend stocks, specifically, Dividend Aristocrats, are a safe and great way to build wealth in the long run. Image source: Getty Images.

Nonetheless, Dividend Aristocrats are among the second-best low-risk dividend stocks after dividend kings (more on that later), simply because 25 years is a really long time, and companies that have been able to increase dividends year after year for decades, regardless of economic cycles, must have sustainable competitive advantages and financial fortitude to be able to do so.

So how many Dividend Aristocrats are there currently, and how do you find the best ones?  Before I tell you, it's important to know a bit about the index that tracks their performance.

What is the S&P 500 Dividend Aristocrats Index?

The list of Dividend Aristocrats is compiled by Standard & Poor's, which launched the S&P 500 Dividend Aristocrats Index on May 2, 2005, to measure the performances of companies within the S&P 500 that have increased their dividends consecutively for at least 25 years. Put simply, if you want to find stocks that have made the cut as Dividend Aristocrats, check this index.

Two major attributes of the S&P 500 Dividend Aristocrats Index worth noting are:

  • Each constituent stock in the index is given equal weight, which simply means each stock constitutes an equal proportion of the index and thus impacts index performance equally.
  • Stocks are diversified across sectors, with no sector, as classified by the Global Industry Classification Standard, making up more than 30% of the index at any point.

S&P believes the latter, in particular, helps the index capture both "sustainable dividend income and capital appreciation potential." To give you an idea about the extent of diversification, here's the index's sector breakdown chart as of May 31, 2018.

A pie chart showing sector-wise breakdown for the S&P 500 Dividend Aristocrats Index.

The S&P 500 Dividend Aristocrats Index has exposure to as many as 11 sectors. Image source: S&P Dow Jones Indices.

The S&P 500 Dividend Aristocrats Index must comprise a minimum 40 stocks. If at any point, the number of companies with 25 years of uninterrupted dividend increases falls below 40, the index may consider companies that have increased their dividends for more than 20 years, provided they meet the criteria for market capitalization and liquidity. In other words, you'll always have at least 40 Dividend Aristocrat stocks to choose from.

The S&P 500 Dividend Aristocrats Index is rebalanced every quarter to ensure that the constituents are equally weighted. It is, however, reviewed only once every year, in January. That's when stocks are added and removed, depending on whether they fulfill the criteria to be a Dividend Aristocrat. For investors, the annual review serves as a checklist to see whether the stock they own has retained its Dividend Aristocrat status and if any new stocks have made it to the list.

That brings us to the most important question: What criteria should a stock fulfill to become a member of the S&P 500 Dividend Aristocrats Index?

Dividend Aristocrat criteria

According to the S&P 500 Dividend Aristocrats Index's methodology, to be a Dividend Aristocrat, a stock must:

  • Be an S&P 500 constituent.
  • Have increased its dividend per share every year for at least 25 consecutive years.
  • Have a minimum float-adjusted market capitalization of $3 billion as of the rebalancing reference date.
  • Have an average daily value traded of at least $5 million for the three months prior to the rebalancing reference date. 

For income investors, it's important to keep the first two points in mind as the other two are more technical in nature. Float-adjusted market capitalization, for instance, includes only the count of shares available to the public and excludes shares held by "control groups, other publicly traded companies or government agencies," as per the S&P. Likewise, average daily traded value refers to the total number of shares that change hands, or are sold and traded, on any given day. 

Interestingly, while the S&P 500 Dividend Aristocrats Index was launched in 2005 to allow investors to track Dividend Aristocrats, S&P published the first list of Dividend Aristocrats in 1989. Between then and now, the elite group of dividend stocks has undergone a sea change.

A brief history of S&P Dividend Aristocrats

The first list of Dividend Aristocrats published in 1989 comprised 26 stocks. Remarkably, nine of the 26 stocks are still part of the Dividend Aristocrat group.

Dividend Aristocrat No. of Years of Consecutive Dividend Increases Payout Ratio (Last 12 Months) Current Dividend Yield
Colgate-Palmolive Company (NYSE: CL) 55 67.6% 2.7%
Dover Corp. (NYSE: DOV) 62 37.4% 2%
Emerson Electric (NYSE: EMR) 60 69% 2.62%
Genuine Parts Company (NYSE: GPC) 62 62.7% 3.12%
Johnson & Johnson (NYSE: JNJ) 55 724.9% 2.57%
Coca-Cola (NYSE: KO) 55 440.7% 3.5%
Lowe's Companies (NYSE: LOW) 55 37.4% 1.97%
3M Company (NYSE: MMM) 60 70.4% 2.65%
Procter & Gamble (NYSE: PG) 62 72.2% 3.94%

Data source: S&P Global Market Intelligence, company financials, Yahoo Finance. Table by author. 

Note that Johnson & Johnson's and Coca-Cola's payout ratios for the trailing 12 months are unusually high because both companies incurred substantial GAAP losses in the fourth quarter because of the recent tax code overhaul.

Interestingly, out of the nine stocks above, Colgate-Palmolive and Genuine Parts Company were dropped from the Dividend Aristocrats list for some years before being reinstated in 2011. A plausible explanation for the exclusion of some qualifying companies from the S&P 500 Dividend Aristocrats Index could be that the index uses the calendar year for dividend analysis. So there's a chance that a company whose dividend increase falls out of the calendar year but within its fiscal year may not make it to the index.

Over the years, several stocks were added to and dropped from the S&P Dividend Aristocrats group, with the list in 2001 holding the highest number of stocks so far at 64.

You can see a common link between the stocks in the table above: Each has increased its dividend for 50 consecutive years or more. Now that's a different league of safe dividend stocks altogether, which is also where the distinction between Dividend Aristocrats, dividend kings, and dividend champions becomes relevant. 

Dividend Aristocrats vs. dividend kings vs. dividend champions

There are several ways to invest in dividend stocks, and even after you decide your preferred dividend investing strategy, you'd still have to make choices. For example, having learned a bit about Dividend Aristocrats by now, the idea of investing in high-quality companies that pay regular and growing dividends may sound enticing. However, even within the dividend growth category, there can be subcategories, three of which are Dividend Aristocrats, dividend kings, and dividend champions.

Investors often make the mistake of using the terms interchangeably. Also, Dividend Aristocrats are more popular than dividend kings and dividend champions, perhaps because it's the only group to have a dedicated S&P index -- the S&P 500 Dividend Aristocrats Index -- to track its performance. That might also explain why the dividend kings and the dividend champions aren't necessarily S&P 500 components like the Dividend Aristocrats. That aside, there are fine lines of difference separating the three.

Dividend Aristocrats: We've already discussed much about Dividend Aristocrats, but to reiterate, they're companies within the S&P 500 that have increased their dividends consecutively for 25 years or more.

You may remember that earlier in the article, I called Dividend Aristocrats the second-best low-risk dividend stocks after dividend kings. In other words, dividend kings are superior to even Dividend Aristocrats.

Dividend Kings: The dividend kings can be considered the best dividend stocks when it comes to reliability and stability of dividends, simply because a dividend king is a company with a record of at least 50 consecutive years of dividend increases, or twice that of Dividend Aristocrats.

That means all of the nine Dividend Aristocrats in the table above are also dividend kings. As of my last count, there are 25 dividend kings in total.

Dividend champions: Dave Fish of the DRiP Investing Resource Center defines dividend champions as simply "U.S. companies with 25-plus straight years of higher dividends." To that end, dividend champions are strikingly similar to Dividend Aristocrats as both include companies that have increased their annual dividends every year for 25 years or more. 

The only notable difference is that a dividend champion may or may not be an S&P 500 constituent. That means the dividend champions group is much larger and offers more choice to income investors, as it doesn't filter out dividend-paying stocks with a 25-plus yearly streak of increases based on market capitalization or liquidity. Fish's last list dated April 30 includes 120 dividend champions.

How many Dividend Aristocrats are there currently?

As of April 30, 2018, also the last date the S&P 500 Dividend Aristocrats Index was rebalanced, there are 53 Dividend Aristocrats.

Aside from the nine stocks mentioned in the table above, other notable Dividend Aristocrats include healthcare companies Abbott Laboratories and Becton, Dickinson and Company, consumer giants Walmart and McDonald's, energy companies Chevron and ExxonMobil, and utilities American States Water and NW Natural Gas.

There were some noteworthy changes in the S&P 500 Dividend Aristocrats Index when it was reviewed this past January as part of its annual procedure. Medical device manufacturer C.R. Bard was removed from the index as it was acquired by Becton, Dickinson late last year. At the same time, three S&P stocks entered the elite group this year, having completed a streak of 25 years of dividend increases:

  • Industrial gases company Praxair
  • Water heater and boiler manufacturer A.O. Smith
  • Diversified industrials company Roper Technologies

The above changes explain why it's important for income investors to revisit their dividend portfolio every year when the index is reviewed to stay up to date on which companies have lost or gained Dividend Aristocrat status and the reasons behind the move. Once you have an idea, you'd want to consider investing in Dividend Aristocrats in either of two ways: stocks or through exchange-traded funds (ETFs).

How to invest in Dividend Aristocrats: Stocks vs. ETFs

The S&P 500 Dividend Aristocrats Index lets you track the performances of Dividend Aristocrats, but you can't invest in the index directly. To gain exposure to the niche group of dividend stocks, you have two choices:

  • Invest directly in Dividend Aristocrat stocks of your choice.
  • Invest in an ETF that tracks the S&P 500 Dividend Aristocrats Index.

The former is active dividend investing that requires you to research stocks to the best of your capabilities, and decide which ones to invest in. The latter, an ETF, is a form of passive investing for those who don't desire or have the time to research stocks. An ETF gives you exposure to a basket of stocks at low costs.

There's only one ETF that tracks the S&P 500 Dividend Aristocrats Index: the ProShares S&P 500 Dividend Aristocrats ETF (NYSEMKT:NOBL). Because this ETF exactly replicates the index, it is better known as an index fund. Like the index, the ETF is rebalanced every quarter, reviewed once every year in January, and currently holds 53 stocks in its portfolio.

With an expense ratio of only 0.35%, the Proshares S&P 500 Dividend Aristocrats ETF is a great investment vehicle for income investors who want to invest in some of the largest-dividend paying companies that prioritize dividend growth over yields.

While a high dividend yield -- which is simply the amount of dividend expressed as a percentage of the stock's market price -- can be tempting, it may not necessarily be safe and sustainable, nor make a stock worthy of your money, especially if the underlying dividends aren't supported by enough cash flows and are stagnant. 

Standard & Poor's has created another index similar to the S&P 500 Dividend Aristocrats Index, called the S&P High Yield Dividend Aristocrats Index. There are two major differences between the two: composition and yield. The S&P High Yield Dividend Aristocrats Index measures the performance of the highest-yielding companies within the S&P Composite 1500 that have increased their dividends every year for at least 20 consecutive years.

That means the S&P High Yield Dividend Aristocrats Index relaxes the basic Dividend Aristocrat rule of 25 years of dividend increases and doesn't restrict itself to S&P 500 components. So an ETF tracking this index, like the SPDR S&P Dividend ETF appears to offer income investors the best of both worlds: dividend growth and yield.

Ultimately, whether you choose to invest in stocks or ETFs is a personal choice and depends a great deal on the amount of effort and time you may have to put into research before betting your hard-earned money. I personally like to deep-dive into companies to select the best stocks to invest in, and I have a system in place to find the best Dividend Aristocrats.

How to identify the best Dividend Aristocrats

By now, you already know that Dividend Aristocrats emphasize little on dividend yield and more on dividend growth, hence the popular method of selecting dividend stocks based on yield isn't useful here.

Instead, look at a combination of other metrics such as total returns (appreciation in stock price plus reinvested dividends), dividend growth rate, and the payout ratio to find the best Dividend Aristocrats to invest in.

Total returns: Because total returns include the impact of reinvested dividends, you can compare a Dividend Aristocrat's total returns with the change in its stock price over a period of time to understand how much dividends contributed to its growth. For example, Procter & Gamble shares returned only about 14% in the past decade, but if you'd reinvested the dividends, the stock's total returns shoot up to 56% during the same period. This example also underpins the power of dividend investing.

Dividend growth rate: Not every company that earns higher profits and cash flows rewards shareholders with big dividend increases. The pace of growth of dividends could depend on several factors, including management's efficiency in allocating capital and commitment to shareholders. Investors in Dividend Aristocrats, though, would want to own stocks that increase their dividends at a steady clip to make the most of their money. 

Payout ratio: Dividend Aristocrats usually have a high payout ratio as they're mature companies that can afford to pay and maintain big dividends. A payout of 65% or below -- which simply means that the company pays out 65% or less of its net profits in dividends  -- should give the company a buffer to pay higher dividends while ensuring it has enough profits to plow back into the business.

Ideally, I'd filter my Dividend Aristocrats list for stocks with double-digit dividend growth rates in at least the past five years and a medium-to-low payout ratio. I'd then analyze the remaining companies for their growth prospects -- looking at new market or product opportunities and business fundamentals -- and select the most promising ones as my top Dividend Aristocrats.

Using the above method, I believe the following five stocks are some of the best Dividend Aristocrats to consider today.

Dividend Aristocrat Payout Ratio (Last 12 Months) 5-Year Dividend CAGR*  10-Year Dividend CAGR*
Ecolab (NYSE:ECL) 30.2% 12.9% 12.3%
W.W. Grainger (NYSE:GWW) 45.7% 10.6% 14.2%
Cintas Corporation (NASDAQ:CTAS) 23.7% 19.8% 13.1%
Roper Technologies (NYSE:ROP) 14.6% 20.4% 18.5%
A. O. Smith (NYSE:AOS) 33.6% 25.5% (2.2%)

*Compound annual growth rate. Data source: S&P Global Market Intelligence. Table by author.

To give you an idea about the kind of growth catalysts I'd look for in Dividend Aristocrats, here's a quick take on three of the above stocks. 

A boring but resilient Dividend Aristocrat 

Ecolab is a global leader in water, sanitation, and energy products. Think institutional cleaning and disinfectant products, medical chemicals, wastewater treatment, pest elimination, and oil and gas solutions. Ecolab, in fact, caters to more than 40 industries across 170 countries and counts some largest industry players among its customers. 

It's a boring, but an incredibly powerful, business. Ecolab's strength lies in its business model: It deals in critical products, has a hugely diversified portfolio and global footprint, and largely operates through multi-year contracts that allow it to lock-in a good portion of revenue in advance. In fiscal 2017, Ecolab generated $13.8 billion in sales and grew its adjusted earnings per share (EPS excluding special items like tax gains) by 7% from 2016 levels to $4.69. The company expects to grow its adjusted EPS by 15.7% at the midpoint in fiscal 2018.

Ecolab has increased its annual dividends for 26 consecutive years and aims to grow its dividend in line  with earnings.

Aside from Ecolab, I find two of the new entrants to the S&P 500 Dividend Aristocrats Index particularly promising: A. O. Smith and Roper Technologies.

A powerful new Dividend Aristocrat

A. O. Smith is a global manufacturer of water heaters, boilers, and water treatment products. Thanks to solid brand power and expansion into international markets, the company grew its sales and adjusted EPS at impressive annual compound rates of 10.5% and 26%, respectively, between 2010 and 2017. Not surprisingly, A. O. Smith started shelling out bigger dividends to shareholders only in recent years, which reflects in its incredible five-year dividend growth of 25.5%.

After delivering a record sales year in 2017, A. O. Smith expects to grow its adjusted EPS by 17% at the midpoint this year. Burgeoning middle-and-urban classes in countries like China and India is one of the biggest growth catalysts for the company. Today, A. O. Smith gets 36% of its revenue from outside North America, with sales from China alone growing at a compound rate of 21% in the past decade to cross $1 billion last year. A dominant position, financial fortitude, and management's goal of achieving 8% organic growth for the next "several years" makes A. O. Smith a top Dividend Aristocrat to own.

An offbeat Dividend Aristocrat

Roper is an industrials conglomerate with several differentiated businesses, including medical and scientific imaging, radio frequency communications technology, water and fluid pumps and meters, and industrial valves and control systems. Roper follows a heavily acquisitive strategy to growth and prefers to reinvest cash into its business over dividends, which explains its measly payout ratio.

Nonetheless, exceptional margins and an incredible streak of generating higher free cash flows than net profits through the past two decades has given Roper leeway to increase dividends year after year and grab a seat at the prestigious Dividend Aristocrats table. After deploying $9 billion on acquisitions in the past seven years, Roper now plans to pump another $7 billion in the next four years. Aggressive growth, backed by an asset-light business model with more than 50% recurring revenue, could mean robust returns from this Dividend Aristocrat. 

Now that I've told you practically everything about Dividend Aristocrats, the question you need to ask yourself is whether Dividend Aristocrats are suitable for you.

Historical returns prove that the S&P Dividend Aristocrats have outperformed the broader market. Yet, low dividend yields may put off some investors, especially in a rising interest rate environment when bonds become more attractive. Likewise, the conspicuous low exposure to high-flying sectors like technology may not sit well with investors seeking high-growth investing.

That said, you'd be surprised to know that even Dividend Aristocrats can be multibaggers: A. O. Smith, for instance, has been a whopping tenbagger in the past decade in terms of total returns.

I believe all income investors, as well as ones with a diversified portfolio, should own Dividend Aristocrats to supplement income. Dividend Aristocrats are also a great fit for your retirement portfolio as they're fundamentally strong, top-quality companies that pay you regularly.

Neha Chamaria owns shares of Colgate-Palmolive. The Motley Fool owns shares of Johnson & Johnson. The Motley Fool recommends 3M, Becton Dickinson, Cintas, Ecolab, and Roper Technologies. The Motley Fool has a disclosure policy.