Wednesday, May 3, 2017

Why Dividends Matter

Over the last several years Dividend Stocks have become immensely popular. It seems that every financial adviser or financial publication is proclaiming that you should own dividend stocks. Each are singing the virtues of dividend stocks from their own perspective.

To that I have two questions:

1. What took you so long?
2. Do you really understand why dividend stocks are such a good long-term investment?

I am entertained that many "experts" are now recommending dividend stocks based on his or her investing makeup. Some are recommending dividend stocks as part of their sector rotation, or as the next hot fad, - stay tuned and they will tell you when to jump out. Others are recommending dividend stocks as substitutes for bonds since yields on fixed income investments have all but dried up.

All arrived at what I consider to be the correct conclusion, but do they really understand why dividends matter? Below are 11 reasons why dividends matter in all markets:

1. In a troubled market, dividends provide investment opportunity

While everyone else is panicked about their portfolio's decline, dividend investors see a downturn as an incredible buying opportunity. The lower a stock's price goes the higher its dividend yield. In a down-market it is a lot easier to buy a stock that pays you an increasing dividend than one that doesn't. Simply put, the dividend stock is paying you to wait on its recovery, while the non-payer may continue to decline of remain stagnate for years.

2. Unlike earnings, dividends can't be manipulated or faked

From an accounting standpoint, it is relatively easy through fraud and manipulation to make an income statement look quite impressive. There is no faking the cash that shows up in your brokerage account. Companies with long histories of dividend increases are less likely to take extreme risks that could potentially jeopardize their streak.

3. Dividends provide continuous feedback

As time passes dividend investors see their income steadily grow. You do not have to wait five to ten years to determine if the strategy is working. Each dividend and dividend increase provides the investor with reassurance that the strategy is working.This reassurance helps investors to the right thing in troubled markets.

4. Reinvested dividends provided a significant portion of the historical equity returns

Performance in any given year is driven by capital appreciation, but long-term returns are largely the result of reinvested dividends. John Bogle, the founder and retired CEO of The Vanguard Group, once wrote:

“An investment of $10,000 in the S&P 500 Index at its 1926 inception with all dividends reinvested would by the end of September 2007 have grown to approximately $33,100,000 (10.4% compounded). If dividends had not been reinvested, the value of that investment would have been just over $1,200,000 (6.1% compounded) – an amazing gap of $32 million. Over the past 81 years, then, reinvested dividend income accounted for approximately 95% of the compound long-term return earned by the companies in the S&P 500.”

5. Good dividend companies grow their dividends

You expect your employer to give you a raise periodically. Why wouldn't you expect the same from your investments? Healthy companies are growing earnings and share price, thus to pay a competitive yield the company must also grow its dividend.

6. Spending dividends in retirement, does not harm your principle investment

Stock prices do not move in a straight line. There are protracted periods were the market moves down. Having to sell more shares in a down market to cover rising expenses, will have a long-term negative effect on your wealth even after the market recovers. In addition, a good dividend portfolio can be left to your children and their children.

7. A dividend portfolio is relatively low maintenance

You may not want to spend your retirement managing and worrying about your portfolio. Careful selection of quality blue-chip Dividend Growth Stocks will provide you a lifetime of growing earnings with very little maintenance needed.

8. Dividends help identify well-managed companies

Companies that grow their dividend on a regular basis tend to be those in better off financially and are able to sustain earnings growth. I(t is no accident that some of the very best companies have been growing their dividends for 30, 40, 50 or more years.

9. Dividend-paying stocks provide a built-in return

Companies that pay a sustainable and growing dividends, are more resilient in down markets. Investors in Dividend Growth Stocks aggressively buy in downturns, which provides support to the stock's  price. In the up markets investors enjoy capital appreciation as earnings grow to support the increasing dividend.

10. Dividend Growth Stocks are an inflation hedge

Eagle Asset Management, in an April 2010 whitepaper noted, "Dividend-paying equities historically have generated income that has kept pace with inflation, an important factor for many investors." Inflation is inevitable. If our income isn't growing, then we are falling behind and our buying power is being eroded.

11. Qualified dividends are taxed at a lower rate

Starting in 2013 the federal tax rates on qualified dividends are 0%, 15% and 20%. The 20% rate is for taxpayers in the 39.6% tax bracket. For those in the 10% and 15% brackets, there is no tax on qualified dividends. In contrast, ordinary income is taxed at rates up to up to 39.6%.

Below are several stocks that have consistently paid dividends through depressions, recessions, world wars, and other political and economic upheavals:

WGL Holdings Inc. (WGL) provides natural gas service in the Washington, DC, metropolitan area and surrounding regions, including Maryland and Virginia.
Yield: 2.5% | Paid Dividends Since: 1852

Exxon Mobil Corp. (XOM), formed through the merger of Exxon and Mobil in late 1999, is the world's largest publicly owned integrated oil company.
Yield: 3.8% | Paid Dividends Since: 1882

Consolidated Edison, Inc. (ED) is an electric and gas utility holding company serves parts of New York, New Jersey and Pennsylvania.
Yield: 3.5% | Paid Dividends Since: 1885

The Procter & Gamble Company (PG) is a leading consumer products company that markets household and personal care products in more than 180 countries.
Yield: 3.2% | Paid Dividends Since: 1891

The Coca-Cola Company (KO) is the world's largest soft drink company, KO also has a sizable fruit juice business.
Yield: 3.4% | Paid Dividends Since: 1893

Colgate-Palmolive Company (CL) is a major consumer products company that markets oral, personal and household care and pet nutrition products in more than 200 countries and territories.
Yield: 2.2% | Paid Dividends Since: 1895

General Mills, Inc. (GIS) is a major producer of packaged consumer food products, include cereal, yogurt and Betty Crocker desserts/baking mixes.
Yield: 3.4% | Paid Dividends Since: 1898

Avista Corp. (AVA) generates, transmits and distributes energy as well as engages in energy-related businesses in the United States and Canada.
Yield: 3.6% | Paid Dividends Since: 1899

Union Pacific Corporation (UNP) operates the largest U.S. railroad, with more than 32,000 miles of rail serving the western two-thirds of the country.
Yield: 2.2% | Paid Dividends Since: 1900

Try telling these companies that dividends don't matter and see what kind or reaction you get. Or more importantly, try telling these companies' shareholders that dividends don't matter. A healthy and wealthy retirement comes from building a secure portfolio, not watching for the next fad.

Full Disclosure: Long XOM, ED, PG, KO, CL. See a list of all my Dividend Growth Portfolio holdings here.

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