Are Dividends Worth Your Attention?
Many small investors may overlook dividends, considering stock investment as solely about buying low and selling high to profit from price differentials. After all, why bother with a mere 2% dividend when you could chase higher returns elsewhere?
However, historical data backtesting paints a different picture: Analysis of stock market returns over recent decades reveals that over 40% of investment returns stem from dividend income, with the remaining 60% attributed to stock price appreciation. This underscores the significance of dividends as a crucial component of overall returns.
In financial theory textbooks, stock valuation sections often present two calculation formulas. One formula focuses on discounting overall free cash flow, more pertinent to valuation for major or controlling shareholders. The other formula, the cash dividend discount algorithm, is particularly relevant for small investors. This is because dividends represent tangible cash flows directly into investors’ hands, making them a critical consideration for individual investors seeking consistent returns.
There are two primary methods through which companies financially reward their shareholders: share buybacks and dividends.
Share buybacks involve the company repurchasing its own shares, effectively reducing the total share capital and boosting the ownership percentage of existing shareholders. This strategy is often favored by major or controlling shareholders due to its tax advantages. Warren Buffett, for instance, initially acquired less than 10% of American Express stock but, through successive buybacks, has seen his ownership stake increase to over 18%. However, share repurchases require meticulous management and financial oversight to truly benefit shareholders. Poorly executed buybacks can erode shareholder value, as exemplified by META, Facebook’s parent company, which spent approximately $50 billion on stock repurchases over the past few years. Despite these efforts, most buybacks occurred at prices exceeding $200 per share. Subsequent market downturns, spurred by Federal Reserve interest rate hikes, saw the stock price plummet to around $100 per share, prompting the company to halt buybacks to preserve cash. Ultimately, such missteps can squander shareholder equity, underscoring the need for stringent financial criteria to guide buyback decisions and prevent impulsive actions detrimental to shareholders’ interests.
The second method of rewarding shareholders is through cash dividends, representing direct cash flows to investors. While the act of paying dividends does not inherently generate additional value, a company’s consistent payment or increase of dividends over many years signifies a healthy business, stable business model, and long-term profitability. Moreover, it demonstrates a management team’s commitment to prioritizing shareholders’ interests, reflecting responsible stewardship. It’s important to note that dividends refer solely to cash distributions, distinct from share issuances and rights offerings, which merely divide the existing pie into more slices without contributing to corporate value or shareholder welfare.
From the perspective of small shareholders, dividends offer several advantages:
- Certainty of Cash Flow: Dividends provide a more predictable stream of income compared to relying solely on capital gains, facilitating easier financial planning.
- Buffer Against Market Volatility: Stable dividends serve as a cushion against fluctuations in stock prices, providing investors with a measure of stability and peace of mind.
- Opportunity for Reinvestment: If dividends are not immediately needed for expenses, they can be reinvested, accelerating the pace of compounding and potentially increasing overall returns.
For small investors seeking dividend stocks, several key factors warrant attention:
- Dividend Payment Stability: Assess whether the company has a consistent track record of paying dividends over many years without interruption. Preferably, look for a dividend history spanning at least five consecutive years.
- Dividend Growth: Examine whether the company has a history of increasing dividends over several consecutive years and evaluate the growth rate. Remarkably, fewer than 60 out of tens of thousands of publicly traded companies in the United States have maintained uninterrupted dividend growth for 25 years. Similarly, continuous dividend growth for 10 years may be rare among listed companies in China.
By focusing on these factors alongside dividend availability and yield levels, small investors can make informed decisions when selecting dividend-paying stocks, enhancing their potential for long-term financial success.
The prospects for dividend continuation hinge primarily on the existing dividend size relative to earnings, ideally not surpassing 80%. This allows sufficient room for future dividend issuance or even increases.
A company’s dividend strategy profoundly influences its long-term stock price trajectory. A consistent and stable record of dividend payments enhances investor confidence, positively impacting stock prices over time. Notably, the nearly 60 companies in the U.S. stock market that have increased dividends for 25 consecutive years have outperformed the average large-company stock by 2% annually. Conversely, unpredictable dividend strategies can detrimentally affect stock prices. For instance, Gree’s decision to halt cash dividends in 2018, citing increased investment in research and development during a period of strong business performance, significantly impacted its stock price. While Dong Mingzhu is recognized as a formidable entrepreneur, Gree shareholders bore the brunt of her arbitrary dividend strategy. In contrast, companies in the Anglo-Saxon system, such as those in the United Kingdom, typically pay dividends quarterly, fostering stability and reliability even amidst economic fluctuations.
Indeed, dividends hold considerable significance, especially for small shareholders. Their reliability and potential for reinvestment contribute significantly to long-term wealth accumulation.
Below is a compilation of stocks that have paid dividends annually for over a century, with the Bank of Montreal boasting the longest record of nearly 200 years of dividend payments. Readers can explore the wealth generated by these stocks over the same period.
- Bank of Montreal (BMO) has been paying dividends since 1829;
- Bank of Nova Scotia (BNS) has been paying dividends since 1832;
- TD Bank of Canada has been paying dividends since 1857;
- CIBC (CM) has been paying dividends since 1868;
- Royal Bank of Canada (RY) has been paying dividends since 1870;
- Stanley Works (SWK) has been paying dividends since 1877;
- Exxon Mobil (XOM) has been paying dividends since 1882;
- Eli Lilly and Co (LLY) has been paying dividends since 1885;
- Consolidated Edison (ED) has been paying dividends since 1885;
- UGI Corp (UGI) has been paying dividends since 1885;
- Johnson Controls Inc. (JCI) has been paying dividends since 1887;
- Proctor & Gamble (PG) has been paying dividends since 1890;
- Coca-Cola (KO) has been paying a dividend since 1893;
- Colgate Palmolive (CL) has been paying dividends since 1895;
- General Mills, Inc. (GIS) has been paying dividends since 1898;
- PPG Industries, Inc. (PPG) has been paying dividends since 1899;
- Church & Dwight Co., Inc. (CHD) has been paying dividends since 1901;
- Chubb Corp (CB) has been paying dividends since 1902;
- Du Pont (DD) has been paying dividends since 1904;
- Edison International (EIX) has been paying dividends since 1910
