Quality at the Core

As investors responsible for growing our clients’ net worth and safeguarding their assets, we believe that the best way to invest is to focus on a select group of high quality companies with growing free cash flow. In our experience, businesses that are well run, well capitalized, and well positioned for growth can deliver positive returns in favorable markets and hold up better in down markets. We call these companies “quality growth” companies, and they serve as the foundation of our core equity portfolios.

Our quality growth approach focuses on identifying companies with three key attributes: 

1. A durable competitive advantage, 
2. an ability to grow revenue at or above GDP levels by reinvesting, and 
3. an experienced, shareholder-oriented management team.

Analyzing companies from this perspective helps us uncover some of the most attractive opportunities in the public markets, spanning a broad array of sectors including Technology, Industrials, Health Care, Financials, and Consumer. When purchased at attractive valuations, these businesses can drive significant shareholder value over time.

Growing Dividends: A Reliable Sign of Strength

There are many types of quality growth companies, but those that consistently pay a growing dividend tend to form the foundation of our portfolios. For a company to pay a growing cash dividend over a substantial period of time, it almost by definition must enjoy a durable competitive advantage that results in significant free cash flow, which can be used to reinvest for growth, and the company likely enjoys solid management and stewardship of its resources. 

In many ways, we view a growing dividend as an outcome of a quality growth business that in turn enforces discipline on the company and its management team, creating a virtuous cycle. Specifically, we find that companies that pay growing dividends tend to focus on growing free cash flow per share over time, manage their balance sheets conservatively, and usually focus on the long term, as maintaining a growing dividend requires a longer time horizon. Once a company initiates a growing dividend, management is usually laser-focused on maintaining that growing dividend, as cutting or freezing the payout can indicate a wide set of issues — from an eroding competitive advantage to excess financial leverage to diminishing growth prospects.

Dividends: A Key Contributor to Returns

In a world of AI, crypto, and “blank check companies,” dividends seem quaint and almost an afterthought to many investors. But dividends matter. Dividends can provide a consistent income stream regardless of market valuations. Over the last nearly 100 years, dividend income has accounted for almost one-third of S&P 500 total returns. Even in recent decades when dividends have often taken a back seat to share repurchase as a form of capital return, dividend income has accounted for roughly 15% of S&P 500 total returns. And in periods of severe market downturns, like the 1970s, dividends can account for fully half or more of S&P 500 total returns. Hence, a portfolio focused on dividend growth can offer investors downside protection in bear markets.

Past performance does not guarantee future results.

Not All Dividends Are Equal (Focus on Growth, Not Yield)

Importantly, we are not yield-seeking. We do not look for companies that carry high dividend yields and pay out most of their free cash flow in the form of dividends. Rather, as noted above, we typically view the growing dividend as an output and a reflection of the quality growth attributes of the business. We prefer a company that generates copious amounts of growing cash flow with ample opportunity for reinvestment to drive future growth. By reinvesting this cash flow — in future sales and marketing, capital expenditures, and/or acquisitions, for example — the company can drive more growth in free cash flow per share over time. But often, the companies we prefer generate so much free cash flow that they can also pay out a modest but growing dividend and/or repurchase equity.

Consider the opposite — a company that is profitable but has little opportunity to reinvest to drive future growth. This could look like a mature retailer, a newspaper, a coal miner, or really any company in a mature industry that is typically highly consolidated, leaving little room for acquisitions. These types of assets at full maturity can produce prodigious free cash flow, and we would argue the best use of that excess cash is a dividend (not share repurchase) to allow remaining investors the opportunity to reinvest the cash elsewhere.

These types of companies tend to sport high dividend yields and may screen as attractive to income-oriented investors. However, we have little interest in these types of assets, even at seemingly attractive valuations, because the companies have minimal reinvestment opportunity and are thus in decline or on the cusp of decline. Often this leads talented employees to flee, resulting in poor management and operations, creating a vicious cycle. These types of businesses may look attractive from a valuation standpoint, but they fetch low multiples on near-term profits because earnings and free cash flow are likely to fall over time, resulting in future dividend cuts.

Said another way, assuming a reasonable valuation,  we would much rather own a vibrant, growing business that is well run and protected from competition that pays a small and growing dividend than a fully mature business that gushes cash but has little productive internal use for that capital. In fact, we often (but not always) see very high dividend yields as a red flag. As a reflection of our focus on growing dividends rather than dividend yield, the weighted average dividend yield of the equities in our core equity strategy tends to be in-line with the broader S&P 500, but the rate of growth of our dividends tends to be higher than that of the broader index.  

Importantly, long-term studies by Ned Davis Research support the view that dividend growth is associated with better returns. In fact, going back to 1973, companies that initiate and/or grow their dividends have delivered by far the best performance among companies in the S&P 500. The two worst quintiles have been those companies that pay no dividends or that cut and/or eliminate their dividends.

Dividend Growth Dampens Volatility

Perhaps the most compelling attribute of dividend growth companies is the fact that these businesses tend to exhibit attractive returns with less volatility over time. In fact, from January 1990 to June 2025, a basket of companies with the longest sustained histories of dividend growth both outperformed the broader S&P 500 index and saw less stock price volatility. Specifically, the dividend-paying basket outperformed materially during drawdowns while still delivering solid returns during periods of broad advances in equities. This lower volatility outperformance is not a coincidence — we believe it results directly from the quality growth characteristics of these businesses. They tend to be protected from competition due to their competitive advantages, they often enjoy secular tailwinds that enable reinvestment for growth, and they are well managed with a long-term mindset that includes conservative balance sheets.

Final Thoughts

We believe that consistent dividend growth is among the most powerful signals a company can send to the market, and historical data supports our view. Companies that have regularly increased their dividends have delivered better returns with less volatility than their peers, and they have also typically performed well in most environments. Moreover, our commitment to dividend growth has helped protect the portfolio from investing in more speculative businesses, as we never want to own a company that has to cut or suspend its dividend. 

At the same time, because our top priority is quality, not just dividend growth, we are also willing to own companies that do not yet pay cash dividends. This affords us the flexibility to invest across every sector, going where the opportunity is greatest. In other words, we can own dynamic, growing businesses while maintaining our discipline.

About Osterweis Capital Management

Osterweis Capital Management is a leading wealth management firm based in San Francisco, serving high net worth individuals, families, and institutions throughout the Bay Area and nationwide. With decades of experience navigating complex market environments, our team delivers disciplined, high conviction investment strategies designed to capture upside in favorable markets and provide protection in challenging environments. We leverage our deep commitment to personalized service to help Bay Area investors build wealth, manage risk across generations, and achieve long-term financial goals.