Why Stocks That Raise Dividends Trounce the Market

There are many different approaches to investing, some of them successful.

But few attain the time-tested success of investing in stocks that consistently raise dividends. And there’s no doubt these stocks have produced astonishing returns, decade after decade.

Unbiased research shows stocks that raise dividends trounce the market, while stocks that simply pay dividends roughly match the market. In what I suppose is an obvious corollary, these stocks historically beat the snot out of stocks that don’t pay dividends, without breaking a sweat between punches. It’s really been easy for them.

OK, let’s run through the research numbers first, then move on to the more interesting discussion of what might be firing them up.

A well-known study by Ned Davis Research shows that from 1972 through April 2009 (the latest data I found) companies with at least five years of dividend growth, and those initiating dividends, punched up average yearly gains of 8.7%, compared with 6.2% for the Standard & Poor's 500.

Companies that maintained steady dividends also gained 6.2% annually, same as the market, but well below what dividend raisers scored.

And non-dividend payers? Lightweights. Beaten down to under a measly 1% a year. Right, under 1% a year for over 36 years. Same story for stocks that cut or eliminated dividends.

In another study, using a different group of stocks, time period and performance measure, AllianceBernstein researched the largest 1500 stocks by market capitalization from 1964 to 1999.

Results? In the year immediately following a dividend increase, dividend raisers’ average total returns were 1.8 percentage points higher than stocks that did not raise dividends.

Compound that over a decade or two of dividend hikes and you can head for the Porsche dealership. (Think I’m kidding? Over 15 years, an extra 1.8 percentage points pops nearly $90K more out of a $285,000 stock portfolio. You don’t have to spend it on a Porsche. But you could.)

Want some more recent numbers, from stocks with decades of dividend increases already under their belt?

Standard and Poor’s research through the end of 2009 shows their Dividend Aristocrats, stocks with at least 25 years of dividend increases, beat the S&P 500 over the trailing 3-years, 5-years, 10-years and 15-years.

And the beating was another knockout, ranging from as ‘little’ as two percentage points annually to as much as nearly five percentage points, depending on the time frame.

So it’s abundantly clear these stocks have better returns. Much better returns.

But why does dividend growth achieve such superb performance? And should investors even care why? After all, more money is more money and that Porsche is still a Porsche.

My opinion? I think there are at least three reasons, and many investors could likely benefit, if they care to look at them.

1.  First, it takes an outstanding business to increase dividends for decades, and outstanding businesses are often outstanding long-term investments. Weak businesses simply can’t and don’t raise dividends for decades.

• So if it’s true, like I think it is, that dividend increases and higher stock prices are both caused, in part, by strong businesses, then it’s vital to understand and monitor dividend-growth companies’ underlying business strength. 
• That’s why you see successful investors evaluating these companies’ revenues, earnings, cash flows, debt levels, returns on capital, stock valuations, and so on, rather than just jumping on the dividend.

2.  Second, I think it’s also likely that a series of dividend increases, in and of itself, eventually helps pull a stock price up.

• After all, if share prices did not follow dividends upward, over time these stocks would end up with monster double-digit yields. 
• But that doesn’t happen because if a yield gets higher than investors think the good health of the business justifies, they buy more of the stock until the yield reverts back down to a more normal range.

All other things equal, there's simply more buyer demand for Johnson and Johnson (JNJ), McDonald’s (MCD), Procter and Gamble (PG) and other outstanding businesses (name your choice) at 4% yields than at 2% yields, so the stock prices move in response.

Of course, all other things aren't always equal. Stock prices are messy, impacted by companies’ outlooks, the economy, market conditions and so forth. 

• But over time, yields that grow too high on healthy stocks revert to normal levels through the mechanism of buyers bidding up stock prices.

3.  Finally, in all that market messiness, investors who stick with a dividend growth strategy enjoy a powerful statistical advantage that amplifies their stock picking.

• This advantage is something statisticians call “baseline probabilities.” 
• To illustrate, suppose a fisherman can choose either of two nearly identical lakes. But one lake has two big fish and eight little fish in it, while the other has the opposite: eight big fish and two little ones.
• At any level of skill and experience, the fisherman’s chances of landing big fish are much better at the second lake. That’s the idea of baseline probabilities. 
• And research studies show there are lots more big fish in the pool of dividend raisers than in the other pools, especially the pool of stocks that don’t pay dividends, filled with so many little fish its average returns approach starvation.

All that said, a dividend-growth strategy isn’t for everyone. (It’s only for people who want to make money … kidding, just kidding!)

For example, skilled traders, technical analysts and investors who’ve simply developed unique expertise in other areas of the market certainly might decide that dividend growth is irrelevant to their investing approach.

As might those who believe corporate America brims with budding Warren Buffetts, all doggedly toiling away at brilliant but so far unrewarded capital allocation programs that make far better use of company cash than dividends would.

And on that note, oddly, some investors seem to delight in arguing that dividend raisers are inferior businesses and, despite the numbers, inferior investments. This, because finance theory says ever-higher dividends waste capital these companies could reinvest back into their business, as non-dividend payers do.

I say “oddly” because the most rudimentary logic tells you that if dividend raisers as a group were capital wasters, and non-payers were capital multipliers, the market wouldn’t reward the raiser-wasters with such monumentally higher returns.

For an in-depth look at the pros and cons of dividends, one that generated a geyser of often coherent comments, check out David Van Knapp’s Seeking Alpha article “Why I Love Dividends.”

And for profiles and analyses of a number of dividend-growth stocks, click thisMore Articles link and take your pick.

Finally, investors who prefer ETFs to stock picking might look at the Vanguard Dividend Appreciation ETF (VIG). VIG’s total returns and dividend reliability have outperformed both the market and popular, higher yielding dividend-growth ETFs.

References and Links

Kiplinger Magazine, “Stocks That Pay Rising Dividends,” August 2009.

AllianceBernstein, “Why Dividends Matter,” November, 10, 2004.

Seeking Alpha, “Dividend Aristocrats: A Comprehensive View,” by David I. Templeton, January 22, 2010.

Additional acknowledgements: Thanks to all the Seeking Alpha authors and commenters who posted data and opinions that helped inform this article.

http://seekingalpha.com/article/193345-why-stocks-that-raise-dividends-trounce-the-market

Dividend Growth: the Hidden Fundamental

Dividend Growth: the Hidden Fundamental

Yield Tells Only Part of the Story

by Michael C. Thomsett

Many investors, even the most conservative ones devoted to fundamentals, tend to overlook or ignore dividend yield as a primary indicator. One reason is that current yield — dividend per share divided by the stock’s price — is somewhat misleading.

Dividend yield is an oddity because the yield increases as the stock price falls. So you could be getting an ever-growing percentage of an ever-shrinking pot. Think back to 2008, for example. When prices of many stocks declined broadly, what happened to a stock falling by $5 a month and paying an annual dividend of $1 per share? As the price fell, the yield rose (see table, below).

In this case, the dividend yield doubled over six months. Good news by itself, but over the same period you lost half your value per share in the stock. This is one of the many reasons investors discount dividend yield as an indicator; it doesn’t reflect the relationship between fundamental value and current price. Whenever the market’s technical side is down — from late 2008 through early 2009, for example — yield is going to be misleading. If a company’s stock price has fallen because of inherent weakness of the company, its sector or the larger economy, the yield isn’t as sound a fundamental indicator as other tried-and-true metrics, such as revenue and earnings trends and the current, debt and price-earnings ratios.

Making Dividends a Reliable Indicator

But there’s another way to analyze dividends to identify exceptional opportunities, even in depressed markets. This requires analyzing dividends as part of a long-term trend and in conjunction with other key indicators. This not only improves the accuracy of the review but also helps narrow the list of viable investment candidates.

As of late April 2009, for example, it was quite difficult to select high-quality stocks based on the traditional analysis of revenue and earnings. So many companies — more than usual by most standards — were available at bargain prices, but were all of these exceptional long-term, buy-and-hold investments? A study of revenues and net earnings doesn’t reveal the distinctions between two types of companies: those most likely to bounce back once the recession ends and those suffering long-term degeneration in value.

Unfortunately, many firms honored in the past as safe and sound blue chips haven’t always endured. For example, General Motors and Eastman Kodak, two of the shining stars of the 20th century, have today become low-value, high-risk has-been investments.

They’re hardly alone. A few years ago, the financial sector was considered among the safest and most promising of long-term investment sectors. Companies such as Washington Mutual, Citigroup and Bank of America were held in high esteem. Today, however, the financial sector is in very poor shape and many companies — including Citigroup — will probably never recover fully.

We need to carefully quantify the popular belief that after prices fall, smart investors should gobble up bargain-priced companies. Investors look for companies that combine demonstrated long-term growth and prospects for stock price appreciation. But revenues and net earnings don’t tell the whole story after a down year. For example, consider these three well-known companies: Johnson & Johnson (ticker: JNJ), Coca-Cola (KO) and General Electric (GE). Which of these hold promise for growth in coming months, and which aren’t as likely to recover? (Companies are mentioned in this article for educational purposes only. No investment recommendation is intended.)



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Let’s begin by comparing 10 years of results for three popular indicators: revenues, net income and dividends per share (see tables, above). A glance at only the revenues and net income seems to place all three companies on the same footing. All have shown a decade of growth, the only major slip being GE’s net income decline in 2008. But the differences are more significant when you compare dividend history. Over the past decade, both Johnson & Johnson and Coca-Cola increased their dividend every year without fail. GE reduced its 2008 dividend for the first time in 10 years.

By itself, the dividend history doesn’t condemn GE. But when viewed with other important indicators, an investor likely will conclude that GE is the least promising of these three companies. For example, the price range for General Electric in 2008 was from $38 down to $12 per share, a drop of 68 percent. (In comparison, Johnson & Johnson ranged between $72 and $52, a 28 percent difference, and Coca-Cola ranged from $65 down to $40, a change of 38 percent.)

Another important difference is found in the debt ratio, the portion of total capitalization represented by long-term debt. Although Johnson & Johnson (15.6 percent) and Coca-Cola (11.5 percent) have kept long-term debt at the same level for the decade, GE’s has increased to 74 percent (not unusual for a company with a financial services arm) from 55 percent 10 years ago.


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Dividend Achiever Status as a Primary Test

Dividend yield is virtually useless as a trend indicator, especially compared with the more meaningful revenue, net profit and debt ratio changes over time. But companies that have increased their dividend every year for at least 10 years — the so-called dividend achievers — tend to be better-managed companies with lower-than-average price volatility, little or no core earnings adjustments and more capability to weather recessionary times. By definition, a company able to increase its dividends has to be in control of its cash flow.

Mergent Corporation follows dividend achievers and has created an index of companies meeting this criterion. In its most recent report, fewer than 300 companies met this important test. (Standard & Poor’s compiles a separate index called the Dividend Aristocrats.)

Increasing dividends every year without fail is a good test of working capital and quality of management. The dollar value of dividends is relatively small. Johnson & Johnson’s dividend of $180 annually for 100 shares is peanuts. But as a symptom of quality, the dividend achiever company is exceptional.

Growth in dividends also is important if you reinvest your dividends automatically through a dividend reinvestment plan, or DRIP. When Johnson & Johnson credits your account with dividends, you can let the cash ride or earn about 1 percent in your brokerage cash account, or you can reinvest it in more shares of Johnson & Johnson and get 3.6 percent on the growing share total. Dividend reinvestment is a smart idea, and with dividend achievers, the compound yield goes up every year.

Dividends by themselves are a small piece of the bigger puzzle. But limiting your search to the very small group of companies that have grown their dividends every year helps cut down the list of potential investments. Combined with analysis of revenue, net income, P/E, debt ratio and other key fundamental tests, dividend trends help you decide whether depressed-price companies are never going to come back — or are the most promising candidates for a strong rebound.


Michael C. Thomsett of Nashville, Tenn., is author of over 70 books. His latest is Winning With Stocks (Amacom Books), which includes practical suggestions for picking stocks based on fundamental analysis. Thomsett is also author of Annual Reports 101 (Amacom Books), Getting Started in Fundamental Analysis (Wiley) and Investment and Securities Dictionary (McFarland).

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0909linespublic.htm