The little-known secret to beating the ASX 200

Many people employ this strategy for income, but it can be pretty useful for capital growth too.

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Beating the market is notoriously difficult.

The reality is that even professional investors can't consistently do better than the S&P/ASX 200 Index (ASX: XJO).

But there is a neat little trick one could pull to assist.

Here's the first way to beat the index

The strategy is to invest in ASX dividend shares.

Many Australians already buy and own dividend stocks for what they're famous for — providing income.

But with the ASX bursting with high yield equities, they can also be used effectively to grow capital faster than the market index.

The idea is that if the dividends are immediately reinvested, then the overall portfolio grows just as well as growth stocks.

To demonstrate, check out how the S&P/ASX 200 Index Accumulated (ASX: XJOA) has done over the years.

That index, which is the ASX 200 with dividends immediately reinvested, stands at an impressive 49.84% gain since January 2019.

Not bad in four years including the COVID-19 and post-pandemic market corrections.

And this is how you turbocharge the portfolio

However, the ingredient that will supercharge a stock into the market-beating zone, according to The Motley Fool US' Matthew DiLallo, is to pick companies that grow their dividend over time.

"That combination of a rising dividend income stream and price appreciation from earnings growth has historically yielded market-beating total returns."

There are some sensational examples of stocks that consistently expand their dividends over time in the US.

"Three of the most well-known among this dividend royalty are Coca-Cola Co (NYSE: KO), Procter & Gamble Co (NYSE: PG), and Johnson & Johnson (NYSE: JNJ). 

"Coca-Cola and Johnson & Johnson notched their 61st straight years of dividend growth in 2023, while Procter & Gamble is up to 67 consecutive years."

Here's an ASX example

While The Motley Fool can't find any ASX shares that have such long winning streaks, there are some historically trustworthy stocks that keep pushing up their distributions.

Washington H Soul Pattinson and Co Ltd (ASX: SOL) is the classic local example. 

The investment company has raised its dividends every year since the 2000s, including through the global financial crisis and the COVID-19 crash.

The dividends are accompanied by decent capital growth too, with the Soul Patts share price rising 63% over the past five years.

One important thing to note with this strategy is that you're not necessarily going for the stocks with the highest dividend yields.

For example, Soul Patts currently hands out a 2.9% yield.

It's more about choosing quality businesses that have the best chance to grow both their valuation and dividends. 

If you bought Soul Pattinson shares five years ago at $19.90, your portfolio would be now enjoying a fully franked 4.7% dividend yield.

Such is the power of dividends.

Motley Fool contributor Tony Yoo has positions in Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended Johnson & Johnson and has recommended the following options: long January 2024 $47.50 calls on Coca-Cola. The Motley Fool Australia has positions in and has recommended Washington H. Soul Pattinson and Company Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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