Steady and rising dividends over the years keep your portfolio growing even when the overall market goes nowhere.
Think out of the box. Everyone says it is the key to success in business, but how do you actually do it? And in the free-for-all, cafeteria food fight that is the stock market, how can you possibly get an edge against all those well-connected hedge funds, large institutions and the investment banks trading their own books of business? The trick is to not try. Don’t play by the house rules. As often as not, you’ll end up buying high and selling low, and paying Wall Street handsome fees in the process.
Instead, play by the rule–your business acumen–that first allowed you to generate the wealth that you are now deploying in the stock market. As early as the 1930s Ben Graham observed how sensible men of wealth when investing in the market displayed a callous disregard of every precept that had brought them that wealth. Instead of using the market instrumentally as a platform for the collection of their share of profits from public companies, investors have become reconciled to treating their hard-earned dollars like so many chips on the green felt of a casino.
Using the market as a means to collect cash payments from companies–it’s called dividend investing, and Wall Street hates it. Investment banks don’t get paid huge advisory fees when a company sends out checks rather than engage in a massive acquisition. Dividend payments don’t generate the commissions for the brokerages that share buybacks do. Wall Street turns a cold shoulder on dividends because there’s nothing in it for them. That’s a shame for investors, because around 90% of the market’s long-term return can be linked directly to dividends–the basic yield and then the growth over time of that coupon. Only about 10% of the return comes from stocks moving (going up) independently of the dividend.
Beyond superior total return prospects, there are other benefits to making sure that your cash is generating cash in turn. The first is volatility, or more specifically, the lack of it. When about half of the dividend investor’s return in any given year is coming from cash payments–whose return is always positive and whose value is not subject to dispute–the investor doesn’t have to worry so much about what the stock market is “thinking.” In contrast, the U.S. market in aggregate offers investors a miserly 2% yield. With such a low cash component, the vast majority of the return–positive or negative–will come from the movement of stock prices. Recall 2008, and then 2009. Was your business down 37% in 2008 and then up 26% the next year? Stock prices change every day and are subject to all manner of emotion and trivial news flow. In contrast, dividends generally change only once a year and reflect the genuine business outlook of a company. That does not change every day. Get off the roller coaster. View your stock market holdings like a business and you’ll sleep much better at night knowing that much of your return from the market is in cash, not some trader’s ever-changing idea of what your business may or may not be worth.
So invest in high yielding, dividend growing securities. You’ll enjoy market beating returns (over the long term) grounded in cash payments to you as a business owner. Sounds easy, right? Well, no. There’s a catch and it’s a big one. The problem is that in a market yielding 2% and with the financial services industry and most investors defining long term as next week, those securities having high yields (above say 4% for anything other than a utility) are seen as having big problems. Something must be wrong with them. They have no growth opportunities or their industries are declining, or whatever the issue may be. Generally, though, the main thing wrong with these companies is that they are out of favor with investors who are quite happy to pay 20 times earnings, and 50 times the cash dividend (2% yield) for a company whose long-term prospects may not be materially different than a company trading at 10 times earnings and 20 times the dividend (5% yield).
Kimberly-Clark Corporation ( KMB – news – people ), the maker of Huggies diapers and Kleenex, is a good example. Wall Street disdains it for its slow and steady growth. But its low profile has translated into an average annual total return over the past decade of 4.14%–dominated by the dividend it has paid and raised every year–that crushed the average annual total return of the broader market–characterized by low payouts, low yields and high growth expectations–of negative 1.81%. Makes you wonder.