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Tuesday, December 9, 2008

* Dividend Investing vs. S&P Index Fund

Part of my kids' college fund is invested in Vanguard's S&P 500 Index Fund (VFINX). When I opened the October statement, I was mildly surprised to see the net asset value had fell below the September 1997 level when the account was first opened. Over the year I have become somewhat disenchanted with mutual funds, ETFs and CEFs due to their recent poor performance relative to my dividend investments.


So what would have happened if I had invested my kids' college fund following a dividend investing strategy? It is difficult to say exactly, but I can make some assumptions and see where it takes me.

Ground Rules
For simplicity, I will select five dividend stocks and purchase $1,000 in each and put $5,000 in VFINX using the closing price on September 30, 1997. Dividends will be held and reinvested on the last day of the year at the closing price. I will ignore commissions and taxes. Final valuation date is as of the end of November 2008, except for BAC (see below). Information was pulled from Yahoo Finance.

Stock Selection
This obviously is the most difficult portion and requires the most self-honesty. I will try to reason what stocks I would have purchased in 1997 without looking at their performance. Since it was for my kids' education, I intentionally avoided the more risky stocks, including REITs. Here are the five stocks I selected and my thoughts as to why:
  • Johnson & Johnson (JNJ): For me the selection of JNJ and PG were no brainers. JNJ and PG are two stocks that have been cornerstones in virtually every dividend portfolio for decades.
  • Procter & Gamble Co. (PG): See above.
  • The Coca-Cola Company (KO): This was a little more difficult form an honesty stand-point. Without looking I suspect that Pepsi (PEP) out-performed KO during this period, but I owned KO in the past and would have likely chosen it over PEP.
  • Bank of America (BAC): Knowing that BAC cut its dividend, it was another difficult selection from an honesty perspective. Knowing what I know now, I would have selected BB&T (BBT), but BAC was the first bank I purchased, so I will go with it. BAC's ending valuation date will be October 7th when I actually sold it.
  • Consolidated Edison, Inc. (ED): Having exhausted the no-brainers and likely choices, this was by far the most difficult selection. Since it was for my kids' education, I targeted a safe stock. As such, I went with the first utility that I bought.
One other stock I considered was General Electric (GE). However, in the late 90's I viewed it more as a growth stock. Let's build the spreadsheet and crunch some numbers.

Results
First let me say that there is nothing definitive you can draw from this analysis - the scope is much too narrow. However, there are some interesting items to consider that could lead to a deeper analysis. With that said, I was somewhat surprised at the results. It was not a good decade for any of the investments that I looked at. The ones I thought would perform well, did not. Here is a summary of the S&P and the five dividend stocks:
S&P 500 (VFINX)
Appreciation as a % of Invested Basis: -10.44%
Total Shareholder Return: 0.90%
Total Dividends Reinvested: $1,168.53
Dividend Stocks In Total
Appreciation as a % of Invested Basis: -13.10%
Total Shareholder Return: 1.25%
Total Dividends Reinvested: $1,609.95
The dividend stocks earned more dividends than the S&P, but also lost more on invested capital. Overall, the return for the dividend stocks was a little over a quarter percentage point higher than the S&P 500. That somewhat surprised me; I expected it to be more. Looking at the individual stocks was quite interesting and not entirely what I expected:
Johnson & Johnson (JNJ)
Appreciation as a % of Invested Basis: -0.12%
Total Shareholder Return: 1.47%
Total Dividends Reinvested: $177.96
Procter & Gamble Co. (PG)
Appreciation as a % of Invested Basis: -7.41%
Total Shareholder Return: 0.46%
Total Dividends Reinvested: $136.52
The Coca-Cola Company (KO)
Appreciation as a % of Invested Basis: -20.77%
Total Shareholder Return: -0.73%
Total Dividends Reinvested: $163.21
Bank of America (BAC)
Appreciation as a % of Invested Basis: -52.09%
Total Shareholder Return: -4.35%
Total Dividends Reinvested: $270.61
Consolidated Edison, Inc. (ED)
Appreciation as a % of Invested Basis: 6.61%
Total Shareholder Return: 6.33%
Total Dividends Reinvested: $861.66
To be honest, I was surprised at how weak JNJ's and PG's performance were over the period. The entire performance of the group was carried by ED. With a -4.35% TSR, BAC actually held up better than I thought it would.

What If..
One case I looked at was substituting BBT for BAC. BBT's performance was better than BAC's but not dramatically. Here are the combined results with BBT in place of BAC:
Dividend Stocks In Total - BBT instead of BAC
Appreciation as a % of Invested Basis: -10.05 vs. -13.10%
Total Shareholder Return: 1.56% vs. 1.25%
Total Dividends Reinvested: $1,610.91 vs. $1,609.95
Conclusion
Contrary to my earlier statement, one valid conclusion can be drawn from this exercise. You should always analytically test your beliefs, because they may not holdup under the microscope.

If you want to see the spreadsheet I used to derive the above data, it is available on my Tools page as Div-Investing-vs-SandP.xls.

Full Disclosure: Long VFINX, PG, JNJ, KO, PEP, BBT and ED

Tags: [BAC] [BBT] [ED] [JNJ] [KO] [PG] [VFINX]

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