What Makes a Tier One Stock?

If you've followed the DGI Crab for any length of time, you've probably noticed something interesting about my Tier One stocks.

Most of them don't have particularly high dividend yields.

In fact, many investors dismiss them because they "only" yield around 1% to 2%.

That's exactly why I like them.

Tier One isn't about maximizing the income you receive today.

It's about maximizing the income you'll receive thirty years from now.

That requires a completely different way of thinking.

The Biggest Mistake Young Dividend Investors Make

Many new dividend investors immediately search for the highest yield they can find.

A 6% yield sounds better than a 2% yield.

A 10% yield sounds even better.

But there's a problem.

Today's yield tells you very little about what your income will look like twenty or thirty years from now.

What matters is how quickly that dividend grows.

A company yielding 1.5% today while increasing its dividend by 10% every year can eventually produce far more income than a company yielding 5% whose dividend barely grows at all.

That's the power of dividend growth.

Tier One Is About Owning Compounders

When I build a Tier One portfolio, I'm not searching for the highest yield.

I'm searching for the highest-quality businesses.

I call these companies compounders.

A compounder is a business that consistently grows earnings, dividends, and shareholder value year after year.

The company doesn't have one great year.

It has twenty.

Or thirty.

Or fifty.

Those are the businesses capable of creating enormous wealth over time.

What I Look For

Before I add a company to Tier One, I ask several questions.

Does it have a wide economic moat?

The best businesses are difficult to compete against.

Sometimes that's because they have powerful brands. Sometimes it's because customers rarely switch providers. Sometimes they benefit from network effects or intellectual property.

Whatever the reason, I want businesses competitors can't easily replicate.

Does it generate recurring revenue?

One-time sales are nice.

Recurring customers are better.

Companies like ADP process payroll every pay period. Waste Management collects trash every week. Visa processes transactions every day. Cintas services customers on recurring routes.

The more predictable the revenue, the more dependable the dividend.

Does management allocate capital wisely?

Great businesses still require great leadership.

I want management teams that consistently reinvest in the business, increase dividends, repurchase shares when appropriate, and avoid reckless acquisitions.

Capital allocation is one of the biggest drivers of long-term shareholder returns.

Has the company demonstrated exceptional dividend growth?

This is where many investors get the equation backwards.

I don't buy companies hoping they'll become great dividend growers.

I buy companies that have already proven they are.

Tier One companies should generally demonstrate the ability to increase their dividends by 8% to 10% annually, or better, over long periods of time.

That's the engine that drives future Yield on Cost.

Has the stock created long-term shareholder wealth?

Dividend growth and share price appreciation often go hand in hand.

A company that consistently grows earnings usually sees its stock price appreciate over time.

That's why I never evaluate dividends in isolation.

I want both. Growing income and growing wealth.

The Common Thread

Take a look at the companies that make up my Tier One portfolio.

Microsoft. Visa. Mastercard. ADP. Cintas. Sherwin-Williams. Parker-Hannifin. Nordson. Waste Management. UnitedHealth.

At first glance, they seem completely unrelated.

Technology. Payments. Industrial manufacturing. Healthcare. Business services. Waste collection.

But they all share something much more important.

They dominate their industries. They possess durable competitive advantages. They generate enormous amounts of free cash flow. And they have spent decades rewarding shareholders through rising dividends and long-term appreciation.

They're high-quality compounders.

That's what I invest in.

Why Yield Isn't My Starting Point

Many investors ask why I don't simply buy the highest-yielding stocks available.

Because yield is only one part of the equation.

If a company pays a large dividend but can't grow it, inflation slowly erodes your purchasing power.

A smaller dividend growing at 10% per year is often far more valuable than a larger dividend growing at only 2%.

That's why Tier One investors should be perfectly comfortable owning companies yielding just 1% to 2% today.

Time is working in your favor.

Let dividend growth do the heavy lifting.

Time Is the Greatest Asset You Own

If you're twenty-five years old, you don't need your portfolio to generate maximum income today.

You need it to generate maximum income when you're fifty-five.

That's a thirty-year head start.

Very few investors fully appreciate how powerful that amount of time really is.

When you combine decades of dividend growth with dividend reinvestment through DRIP, the results can be extraordinary.

That's why Tier One exists.

It's designed to take maximum advantage of the one resource young investors have that older investors don't.

Time.

Final Thoughts from the DGI Crab

Tier One isn't about chasing the next hot stock.

It isn't about finding the highest dividend yield.

And it certainly isn't about taking unnecessary risks.

It's about buying exceptional businesses that have already proven they can compound earnings, dividends, and shareholder wealth over long periods of time.

Wide economic moats. Disciplined management. Recurring revenue. Growing dividends. Growing earnings. Growing share prices.

That's the formula.

Find enough businesses like that, give them time to work, and they'll do most of the heavy lifting for you.

That's what makes a Tier One stock.