The first ten years of this new millennium provided an exciting opportunity for investor education – it provided a “lost decade” in U.S. equities. Book-ended by two massive bear markets, just as the demographic reality of baby boomer retirements began, investors were given a chance to remember what investing is supposed to be about, and what can lead to disaster. Through the turbulent first decade of this new millennium, and the post-financial crisis reality since, the assumptions that drive investor behavior and decisions have been challenged, and hopefully informed. And from the decades that pre-dated this new millennium, and everything we have seen since, one thing stands out … Dividend Growth investing represents a mathematical miracle that creates an offense and a defense for savvy investors that stands the test of time.
The investment industry has convinced us that there are “growth” investors, and there are “income” investors; there are “conservative” investors, and “aggressive ones. But the fact of the matter is, with all the different nuances in risk appetite, timeline, personality, sophistication, and anything else, all objectives and descriptions end up coming down to one thing … a receipt of cash. The rest is just details.
There was a time that dividends were half, or more, of the annual return stocks offered. But as dividend yields have dropped across broad equity indices, are we to believe that price appreciation will be substantially higher than its historical average, to equal past total returns? In reality, companies that have stood the test of time become dividend payers. Technology is proving this true of entire sectors. The past and future are about companies rewarding their shareholders with profits paid out as cash. And in studying the history of this, we learn a lot we need to know about the future.
Yes, the dividend is cash we put in our pocket. Yes, the dividend is a continued and realized form of reward (compensation) in exchange for the investment made into the company. But what too many miss is not what the dividend does for us as investors, but what the dividend tells us about the company we own. Shareholder alignment with management matters. And so does the “tell” of a cash payment in a world of crazy accounting.
Before we talk about the advantage of dividends for those withdrawing from their wealth, we need to look at the equally potent force of people using dividends to accumulate wealth. That accumulation story causes us to look deep into the miracle of compounding. In fact, we will see that the reinvestment of dividends in a fully diversified dividend growth stock portfolio, is actually a story of compounding within compounding within compounding – a leveraging of math and time that ought to be irresistible.
Investment advisors have been building financial plans around “systematic withdrawals” from diversified portfolios forever. But what if the assets one is withdrawing from are in an [inevitable] period of decline? How does one withdrawing from their nest egg insulate themselves from the realities of a bear market? One fact changed my thinking forever – stock price appreciation goes positive, and negative; dividend payments can only be positive. Fluctuation in value is part of being an investor, but tapping the source of only positive returns in negative markets goes a long way to preserving your income flow for the long haul.
Perhaps compounding the reinvestment of dividends is a great way to build wealth around stable, healthy companies. And perhaps the withdrawal of a growing flow of positive dividend payments is a defensive way to ensure your cash flow needs are not exposed to bad timing risk. But is the cost of this strategy a significantly lower total return over time? Is the opportunity cost severe? Not only is the Yield on Original Investment something investors must understand, but they may be shocked at the real performance history as well.
The loss of purchasing power is one of the greatest threats investors face, and no shortage of strategies exist as to how to deal with it. But rather than speculate on wildly volatile commodities or metals which offer no internal rate of return, why not look at the most historically verifiable method of defeating inflation we have found? Companies that can increase their prices with the reality of inflation (after all, is there inflation if they are not doing such?), and companies that can (and do) increase the dividend they pay us along the way!
The systemic change in executive compensation over the last 20-25 years has also led to a systemic change in how companies return cash to shareholders. An analysis of the pros and cons of different ways companies do this, and what it means relative to dividend growth provides pleasant surprises for investors.
The vast majority of the dividend growth orientation is undermined by companies that cut their dividends. Indeed, many advisors avoid this approach to investing because it cannot be merely indexed by backward-looking understanding of a company’s dividend habits. What goes into the hard work necessary to find sustainable dividend growth in the companies that belong in a quality growth and income portfolio?
The most common mistake people make is believing that “high yielding” stocks are the pot of gold dividend-growth investors are after. But sometimes the surest way to end up with a “no yield” stock is to buy a “high yield” one. The differentiation between high yielders and tomorrow’s growers is striking. Free cash flow vs. good intentions is important. And “sectors” are not.
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