Re(de)fining Quality: The Philosophy Behind High Quality Dividend Investing

Evaluating Business Quality Via Dividend Policy

Factor investing has developed broadly accepted definitions for value, momentum and size. The definition of quality, however, remains less uniform, with some quality strategies emphasizing profitability and return on equity while others focus on earnings stability, low leverage, or conservative accounting. These measures are useful, but they do not fully capture what a dividend can reveal about management’s confidence, financial capacity, and capital-allocation discipline.

There are few windows into management’s confidence as unambiguous as dividends. Academic research has long examined the information contained in dividend policy. John Lintner observed that companies tend to adjust dividends cautiously because management seeks to avoid increases it may later reverse. Research that followed found that dividend changes can contain information about subsequent profitability beyond contemporaneous market and accounting data^1,2. Broader quality-factor research also recognizes payout policy as a dimension of corporate quality.³

“One of the most persuasive tests of high quality is an uninterrupted record of dividend payments for the last 20 years.”

- Benjamin Graham | The Intelligent Investor⁴

At Breckinridge, our investment strategy is about more than simply owning quality companies. It is about identifying quality dividend-paying companies: dividends that we believe are reliable, responsibly funded, and can consistently increase due to growing earnings. An increase in the regular dividend can be a meaningful signal of management’s confidence in future earnings and cash flow, as companies understand the consequences of raising a dividend and subsequently cutting it. 

Applying a credit lens to dividend policy strengthens this quality case. For investment grade companies (the investable universe for Breckinridge’s HQD strategy) that discipline can be especially important because a dividend cut may be of concern to both debt and equity holders.

Dividend Quality as a Category: Not Just Yield nor Simply Growth

A high-dividend strategy generally emphasizes companies with high current yield. A dividend-growth strategy typically rewards historical growth rate or consistency of dividend increases. As noted earlier, a conventional quality strategy generally starts with profitability, leverage, and earnings stability. Dividend Quality integrates all three perspectives but treats none as sufficient on its own.

This integrated perspective addresses a key gap: a high-quality company may pay no dividend, while alternatively, an apparently attractive dividend may be unsupported by the underlying business. Dividend Quality asks whether meaningful current income can be supported and grown without weakening the enterprise or limiting profitable reinvestment. Dividend quality, then, is the link between credit worthiness and dividend reliability, as high quality investment grade companies have the propensity to be reliable dividend payers.

With all this in mind, Breckinridge’s philosophy behind the High Quality Dividend strategy is as follows:

"Quality businesses display their durability by growing their dividends. As such, dividend growth is emblematic of quality, and investors may benefit behaviorally from having tangible evidence of the financial strength of the companies they own.”  

- Peter Coffin | Breckinridge Capital Advisors

We also believe that Credit Quality informs Dividend Quality because creditors have a senior claim on cash. A company that can comfortably meet its contractual obligations is more likely to have the residual capacity to pay a dividend, but it may choose not to do so or prioritize reinvestment and repurchases.

Dividend Quality can signal strength in business fundamentals because a well-funded, consistently growing dividend may provide evidence of enduring cash flow generation and capital-allocation discipline. Yet a company may temporarily maintain a dividend through borrowing, asset sales, or an excessive payout, which is why the dividend cannot be interpreted independently.

Credit and Dividend Quality thus offer complementary evidence of corporate quality. Their intersection represents a distinct style of investing. 

From Investment Philosophy to Process

Our investment philosophy is transformed into a repeatable security-selection framework through Breckinridge’s proprietary Dividend Internal Scoring Model (i.e., Dividend ISM). The Dividend ISM evaluates securities based on their capacity to sustain and grow an appropriately sized dividend while continuing to reinvest in the business.

Breckinridge defines the eligible universe to include U.S. large cap investment grade companies with an established history (10+ years) of continuous dividend payments. Each company meeting initial screening criteria is then quantitatively scored across five dimensions, and the resulting signals are evaluated together rather than used as independent screens.

• The proprietary credit rating assesses balance-sheet strength, business resilience and cash-flow durability.
• The payout ratio evaluates the cushion supporting the dividend and the capital retained for reinvestment.
• Dividend yield and dividend growth measure the income delivered and the record of increasing that income.
• Return on equity indicates whether the company can use shareholder capital productively. 

The resulting Dividend ISM score reflects these measures as controls on each other. For example, an unusually high yield would be counteracted by deteriorating credit quality; fast historical dividend growth would be countermanded by an excessive payout ratio; and high profitability does not produce dividend quality when capital allocation is inconsistent or unsupported. In total, we believe the Dividend ISM is a true differentiator on quality (See Figure 1), where HQD consistently ranks higher than both the overall market, represented by the Bloomberg 500 (B500) Index, and a well-known quality proxy in QUAL.⁵

The ISM factor equally weights return on equity, payout ratio, dividend yield, dividend growth and Breckinridge proprietary credit rating, and is recalculated quarterly. To be eligible, a company must have >$10B market cap, possess an investment grade rating, and have a 10-year history of consistent dividend payments. Where Breckinridge investment grade ratings were not available, S&P current ratings were used. Dividend history for companies were added from either QUAL ETF or B500 indices determined by evidence of dividend yield > 0% as of each respective period’s quarterly end date and 10 years prior to that. The B500 list of constituents was gathered every other quarter (except for 06/30/2026 and 09/30/2026 periods which were both used as is) and QUAL holdings were updated every quarter. QUAL is the MSCI iShares MSCI USA Quality Factor ETF. It was selected because HQD has a quality bias and QUAL is one of the most well recognized quality ETFs in the industry and has about $48B in assets.

Importantly, we believe these characteristics can provide strong evidence of the quality of the underlying business and the consistency of its earnings. Reported earnings are an accounting measure, necessarily shaped by assumptions, estimates, and judgments. Instead, we focus on dividends. Dividends are different. Dividends are definitive. Dividends are cash. A company that regularly pays and increases its dividend is quite literally walking the walk and not just talking the talk.

The (Counter)intuitive Payout Ratio

Breckinridge’s HQD investment process favors companies with lower dividend payout ratios. This distinguishes our philosophy from many other dividend equity strategies, where higher payout ratios are intentionally part of the design plan, or as they say in the technology sector: viewed more as a “feature than a bug.” 

“We do not see things as they are; we see them as we are.”

- Anaïs Nin

Our objective is not to maximize yield, but to own high-quality businesses capable of consistently growing a dividend while retaining substantial earnings for future growth. A lower payout ratio can cushion the dividend during difficult periods, create capacity for future increases, and retain capital for business growth. We therefore do not view dividends and growth as competing objectives. Ultimately, we believe that most equity investors want to own businesses capable of growing their earnings over time. High-quality, dividend-paying companies are able to satisfy both objectives: investing sufficiently in their business to support future growth while returning a growing stream of cash to shareholders. 

Lesson from Behavioral Economics: Quality’s Underappreciated Benefits

A critical benefit of holding Dividend Quality stocks for investors is that the receipt and growth of dividends are observable outcomes. During periods of market stress or temporary underperformance, those outcomes can reinforce the investment thesis and help investors distinguish a change in stock price from a deterioration in business quality. Said differently, stock prices are typically far more volatile than the underlying businesses they represent. For an investor, consistent dividend policy and growth can offer true insight into the stability of the underlying business. 

Behavioral benefits of Dividend Quality help support the very important “sleep well at night” test. Every strategy, held long enough, will have a period of cyclical underperformance and/or face a punishing bear market. The question is how do investors manage their own behavior during those periods? Capital is often destroyed by buying at euphoric highs and selling near panic-driven lows. This has been well illustrated by Morningstar’s “investor return gap” calculation, which shows the average dollar-weighted returns based on when investors purchased and redeemed U.S. mutual funds rather than total returns based on an initial lump sum purchase. As expected, average dollar-weighted returns lag total returns, with the most recent study showing the former at 8.7 percent vs. the latter at 9.9 percent for the 10-year period ending 12/31/2025⁶. This equates to a significant 12 percent total loss over 10 years, likely because investor behavior is impacted by market volatility and their emotional swings. 

It is during down markets, in particular, that understanding the anatomy of an investment is critical to avoiding common behavioral mistakes. Dividends cannot prevent losses, guarantee positive returns, or substitute for valuation discipline. High quality dividends can, however, provide a timely reminder of the defensive nature typically exhibited by quality businesses that continue to generate cash, display financial strength, and, at times, raise their distributions during periods of market stress^7,8.

Conclusion

The companies held in Breckinridge’s HQD strategy have historically grown their dividends well above the S&P 500’s average dividend growth rate, while tending to exhibit more defensive characteristics in aggregate. 

We believe that the value of a dividend lies not only in the income it provides, but in what it reveals about the quality of the underlying company. That lens, along with the thorough assessment of a company’s financial resilience, provides for a narrower, but more robust, measure of business quality. These philosophical tenets underpin Breckinridge’s Dividend Internal Scoring Model and translate into a repeatable, rules-based investment process for constructing and managing the portfolio. For investors and advisors, Breckinridge’s HQD strategy may be well-suited to deliver current income, dividend growth, capital appreciation and attractive risk-adjusted returns. As such, it may be a differentiated option as they (re)assess large cap core, quality or dividend equity allocations.