Monday, August 20, 2012

More on the Value of Dividends in Long Term Investing

Cash dividends are in vogue these days as the yield is often greater than government bonds for the first time in a long time.

The fact is, however, that until the 1950s dividend yields generally were in excess of yields on bonds and other fixed income investments. Maybe we're simply "reverting to the mean."

In any event, the history of stock market returns is one heavily dependent on dividends. Since many people today are unaware of that simple fact, I want to emphasize it over the next several weeks and months. My own view is that we're at an interesting, and perhaps historic, turn in the investment cycle where increasing earnings and dividiends wil go hand in hand to help invididuals achieve investment returns which will (1) preserve inflation adjusted purchasing power, (2) add to that power and (3) diversify their holdings by reinvesting the dividends is similar companies.

Dividend strategy for the serious investor has this to say about the rationale behind investing for dividend growth:

"Widows-and-orphans stocks. That's what the brokers used to call the dividend strategy. During the go-go 1980s and later the tech boom, any stock offering a dividend was suspect, according to the so-called "active" investors. . . . Safe, sleepy, ho-hum, boring.

Except the traders forgot to do the basic math. Dividends are a huge part of total return on stocks, and a serious dividend strategy is central to the wealth-building power of a properly allocated portfolio. Ben Inker at the money management firm GMO explains the impact of dividends in a recent white paper. 

Real earnings growth per share since 1929 has been 1.7% a year. Economic growth measured by GDP has been 3.3% Meanwhile, the real return on stocks has been 5.9%, he points out:

When we look at stock market returns, dividends have a very large impact on the total, providing the bulk of equity investor returns for most of history. The gap between the 1.7% real earnings growth (about half the rate of GDP growth) and 5.9% real return (almost double the rate of GDP growth) is made up by dividends, which have averaged about 3.9% since 1929, and a bit of valuation shift (the P/E of the market is a couple of points higher today than it was in December of 1929).

So, am I saying that you should dive headlong into a dividend strategy? Of course not. Dividend payers have had a great run of late, with many of the consumer goods stocks making all-time highs. If you bought them a few years back, it may be time to take some of that appreciation off the table through rebalancing. . . .

The point for the long-term, passive investor is simple: You can have it both ways. It's possible to get the growth you need from stocks, but a major part of that growth will come from compounding and a simple, somewhat boring dividend strategy. It's an unavoidable fact. . . .

So, yes, buy dividend stocks. But do it the smart way, safely, as part of a serious, long-term retirement plan." 
Summing Up

For those of you who have the interest and time to learn more about historic stock market returns, the relationship of those returns to GDP growth, reversion to the mean in share prices, and the role of dividends in long term investing, please read the GMO white paper referred to hereinabove.

It's well worth the effort to spend at least a few minutes with it.

Thanks. Bob.

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