Dividend Growth investing is simply amazing.
You can make a one-time investment, and get paid a growing stream of income for the rest of your life.
And on top of this?
Dividend growers have historically outperformed.
Today, we will be looking at the characteristics we need our dividend growth portfolio holdings to have in order for us to outperform over the long term.
🧮 Sources of Returns
It’s always important to review the 3 potential sources of returns:
Earnings per share growth
Multiple expansion/contraction (Price to earnings ratio growing/shrinking)
Dividends
For example, here is what the sources of returns look like for the S&P each decade:
Some decades (like the 2010s), earnings growth was the main driver of returns.
Some decades (like the 1980s), multiple expansion was the ultimate driver of returns.
And some decades, when market performance was particularly poor-
Dividends were the main driver of returns, and sometimes the only positive source of returns.
We must note that over the long run, share price follows earnings growth.
📈 Outperforming the Market
Many of the decades (not all) where the S&P 500 had above average returns were primarily driven by:
Earnings growth
Multiple expansion
These are the ultimate engines of market outperformance over the long term.
The math behind this is simple.
Let’s say we have a stock that grows earnings per share at 15% per year.
At a 15% annual growth rate, earnings would double in about 4.8 years
Assuming that:
The stock doesn’t pay dividends
The P/E multiple stays the same
This means that the share price of the stock over the 4.8 year time period would double as well.
A 100% gain in just 4.8 years!
But let’s run this scenario one more time…
This time we will assume the stock is trading at a price to earnings multiple of 15.
Like above the stock continues to grow earnings per share at a rate of 15%.
But at the end of the 4.8 year period, the company is trading at a P/E multiple of 25.
To review:
EPS grows at 15%
The P/E multiple expands from 15 to 25
This means the stock would provide a total return of 234% in just 4.8 years!
🛒 Walmart Case Study
Walmart is a great case study of ‘sources of returns’ right now, with the stock close to a 52 week low.
First, let’s make a simple acknowledgment:
Walmart is an excellent business.
The company generated more than $713 billion in fiscal 2026 revenue, $41.6 billion in operating cash flow, and $14.9 billion in free cash flow.
The underlying business continues to grow, produce stable cash flows, and gain market share-
And to some degree, could be considered ‘AI proof’.
From February 2016 through January 2026, Walmart delivered a total return of 542.2%, or approximately 20.6% annually!
However, look at where those returns came from:
104.1 percentage points from earnings growth
103.4 percentage points from dividends
334.7 percentage points from multiple expansion
Nearly 62% of Walmart’s total gain came from investors paying a higher valuation multiple for the same business.
Multiple expansion is easily justified if a company is significantly widening their MOAT or projected to grow earnings at a much faster rate in the future.
However, Walmart had climbed to a high P/E multiple of roughly 45x near the beginning of 2026.
The dividend also provided very little protection at that valuation, with the yield below 1% at and a 5 year dividend CAGR of roughly 6%.
Investors were receiving a sub-1% starting yield, moderate dividend growth, and an earnings yield of less than 3% based on the forward P/E multiple.
The result was Walmart significantly underperforming the broader market so far in 2026.
The underlying business is still performing well-
But the stock is underperforming because its elevated starting valuation left very little room for anything less than exceptional results.
Even when earnings and dividends continue growing, multiple contraction can overwhelm those operational returns.
This is why identifying a great company is certainly a great first step, but we must also understand what are their potential sources of returns moving forward.
Let’s look at a recent example where sources of returns worked heavily in my favor.
🏅Microsoft Case Study
Some may call it hindsight bias, but the easiest investment I ever made was when I made Microsoft my largest position back in 2022.
The reasons I had such high conviction on this investment, was because I was looking at Microsoft through the lens of what my potential ‘Sources of Returns’ were.
Let’s look at the history of MSFT.
From January of 2000 to 2010, MSFT stock declined by -47.7%.
However, during this time period, EPS grew from $0.89 to $2.13.
That means EPS grew at a compounded annual growth rate of 9.1%!
MSFT also started paying dividends in 2003, with an initial yield of 0.55%-
And grew the dividend at a 7.1% CAGR through 2010.
What does this mean?
Microsoft was providing double digit operational returns (Dividend Yield + Earnings Growth).
But the entire decade of returns was destroyed by multiple contraction.
The P/E multiple for MSFT was well over 50 at multiple points in the year 2000.
Buying stocks at an overvaluation can destroy decades of returns.
Compare this to my investment in MSFT in 2022 over a 3 year time period.
During this time, MSFT has grown EPS at a compounded annual growth rate of 12.7%.
The yield was above 1%, and grew at a near double digit rate.
They were providing a double-digit operational return annually.
But here’s what really made the difference.
MSFT was trading at its lowest PE multiple in over 5 years, at below 25.
Even if the PE multiple for MSFT remained unchanged-
I would still have gotten:
12.7% returns from EPS growth
Over 1% returns from dividends (plus dividend growth!)
Near 14% returns annually.
But the market realized it’s mispricing of MSFT, and the PE multiple has climbed significantly.
This led to total returns of well over 100% in just a 3 year time period.
🔍 S&P 500 Sources of Returns
Shall we dive deeper into this concept?
The chart below is one of the most important charts you’ll see today.
It shows the underlying sources of S&P 500 returns since the beginning of 2020-
However, it shows the sources on a much more detailed level.
It shows exactly how and why earnings grew.
Through August 2026, the S&P 500 generated a cumulative real return of approximately 114%.
That means the return is adjusted for inflation.
The chart breaks that return into six components:
Organic sales growth: +27 percentage points
Margin expansion: +29 percentage points
P/E multiple expansion: +36 percentage points
Buybacks: +19 percentage points
Dividends: +14 percentage points
Share dilution: −11 percentage points
Together, these components explain the market’s approximately 114% inflation-adjusted return.
Two things immediately jump out.
First, look at what happened in 2022.
Fundamentals kept improving.
BUT-
The S&P 500’s cumulative real return since the beginning of 2020 fell from approximately 50% to nearly 13%.
Why?
Because the collapse was primarily caused by valuation multiple contraction.
Investors were suddenly willing to pay much less for each dollar of corporate earnings.
A company can continue growing sales, earnings, and dividends while its stock price falls because the valuation multiple contracts (like we saw above for Walmart).
This is one of the biggest advantages for dividend growth investing, particularly for retirement.
Your portfolio value can still decline significantly when valuations compress.
This is detrimental if you are planning to utilize the 4% rule.
However, if your living expenses are funded by a growing stream of dividends-
You are less dependent on selling shares at whatever valuation the market happens to assign them.
Basically, as we discussed last week, this alleviates you from sequence of returns risk.
But the second important takeaway is something we didn’t point out last week.
It’s the fact that P/E multiple expansion has been the single largest contributor to S&P 500 returns since 2020, adding approximately 36 percentage points.
At first, that sounds concerning (and to some degree it is).
Returns driven by multiple expansion are generally less durable than returns driven by sales and earnings growth.
Valuations cannot expand indefinitely, and the same force that boosted returns can eventually work in reverse.
But there has been meaningful fundamental growth supporting the market’s return.
The risk is that valuations are now placing greater demands on that future growth.
Of course, this brings us to the never ending debate as to whether or not we are actually in a bubble.
🫧 Is There a Bubble?
During the dot-com bubble, Cisco’s share price became completely disconnected from its forward earnings expectations.
Nvidia looks radically different.
Its share price has surged since 2020, but forward earnings expectations have risen alongside it.
Here’s the caveat to this:
If we are in a bubble today, it may be embedded in the earnings expectations themselves, not the price of the stock.
The market is assuming that AI demand, spending, margins, and earnings will remain extremely strong.
But if those expectations prove too optimistic, earnings estimates could decline while valuation multiples contract at the same time.
so if we look at this scenario through the lens of sources of returns, we would se a severe decline in the valuation multiple AND earnings.
This brings us back to the unique role of dividends.
Share prices, earnings expectations, and valuation multiples can change rapidly.
However, a well-covered dividend supported by durable cash flow is one of the most stable and predictable sources of returns.
Dividends provide a source of return that have proven to be incredibly reliable over the years.
Obviously that does not make every dividend safe.
But companies growing free cash flows with strong balance sheets, and healthy payout ratios can continue paying and growing their dividends while the market works through an earnings or valuation reset.
The chart below is a perfect example.
S&P 500 dividends grew during every decade shown, even when share prices struggled.
Not only that, but the dividends grew at a rate substantially higher than inflation.
The reality is that the dividend growth investor doesn’t need to be concerned as to whether or not we are in a bubble, as your income continues to climb higher regardless of market conditions.
⚡Our Dividend Growth Portfolio
The goal of our Dividend Growth Portfolio?
Buy stocks that allow us to benefit from all 3 of the sources of returns.
If you want to be a part of the process of building this portfolio and also get access to everything mentioned below, you can join here:
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