The Power of Strategic Dividend Growth
Dividend Paying Stocks Dominate
The chart below shows the performance of S&P 500 companies from 1972 – 2012, broken down by dividend payment policy:
Source: Ned Davis Research
There’s quite a bit of data in this chart so let’s start by highlighting a few key points:
This chart clearly shows the power of owning dividend-paying stocks over time. However, it’s not as easy as simply picking stocks that pay high dividend yields and holding them indefinitely. Stocks with abnormally high yields often fall into two categories:
Therefore, investors are best suited to focus on the most attractive risk-adjusted dividend potential rather than just the stated yield.
Give it Time
Now that we’ve shown that an investor can do quite well by staying on the blue lines and avoiding the dark green one, we now need to explain why a long-term investment horizon is critical when investing in dividend payers.
When a company pays a dividend, the value of that firm falls by the amount of the dividend paid. For example, if a firm is worth $500 million and they paid a dividend totaling $50 million to investors, then the resulting value of the firm is $450 million ($500 – $50 = $450) after the dividend was paid with cash in the firm’s bank account. Since the firm now has $50 million less in the bank, the stock price must be reduced by that amount as well, since the value of the firm is now lower.
The key point here to remember here is that shareholders theoretically do not gain or lose from a dividend at the time of payment. They receive the dividend amount in cash equivalent to the amount of loss in stock price.
Therefore, an investor must be patient and wait for the company to rebuild that $50 million in value by selling more goods and/or services. Those companies who continually replenish the amount paid tend to have stocks that fall on the dark blue line above. They pay consistent dividends because their revenues are also consistent.
If our hypothetical firm were able to not only replenish the $50 million but actually grow that figure over time, then they would likely end up on the light blue line above (the most profitable group of investments on the chart). For example, if the firm grew profits to $60 million this year and $70 million next year, then company management could raise the dividend payout to reflect their growth in profits.
Simply put, investors must give dividend paying stocks time to replenish the value lost by paying the dividend to shareholders. Investors skilled at finding these companies that can perform this process of generating profits and distributing them to shareholders consistently will most likely be rewarded over the long run.
NOTE: Companies unable to replenish that $50 million payment tend to gravitate towards the dark green line over time. Once a firm realizes that they cannot support their dividend, they will cut it or suspend it entirely, which almost always crushes the stock.
Implications for Investors
In an ideal world, keeping a portfolio highly concentrated on the blue lines would be easy, however, it’s quite the opposite. Investors need an active manager for this type of investing because knowing how to determine whether a stock’s future is on a blue line or the dark green one requires tremendous skill and experience.
The Investment Committee consists of seven highly experienced professionals who have been trained to look through a company’s financials to determine the health of their dividend. These stocks are pervasive throughout most of the DIAS portfolios given their potential for strong income generation and capital appreciation.
Furthermore, we have partnered with Federated Investors to offer our investors the opportunity to allocate a portion of their overall portfolio to dividend growers through the Federated Strategic Value (FSV) fund. This strategy offers an investor a highly targeted approach to owning stocks that Federated’s team expects to end up on that light blue line above.
NOTE: While we encourage investors to consider FSV, we strongly urge that you consult your financial advisor to determine the appropriate allocation given your risk profile and investment objectives. Volatility tends to be higher in equity-only portfolios and will require a long-term investment horizon.
The bottom line is that stocks that offer dividend growth over time tend to significantly outperform other dividend paying policies. Federated’s Strategic Value portfolio is a great way to create a targeted allocation to this group of stocks managed by a team of highly skilled investment professionals.
This commentary is not intended as investment advice or an investment recommendation. It is solely the opinion of our investment managers at the time of writing. Nothing in the commentary should be construed as a solicitation to buy or sell securities. Past performance is no indication of future performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global Financial Private Capital is an SEC Registered Investment Adviser.
We are an independent financial service firm helping individuals create retirement strategies using a variety of investment and insurance products to custom suit their needs and objectives. Financial planning, investment advice and insurance provided through Business-owner Strategies Group, LLC a North Carolina Registered Investment Adviser and Licensed Insurance Agency d/b/a BSG Advisers. Wealth CAPS does not provide legal or tax services.