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With the first two months of 2016 being characterized by heightened market volatility, I thought it would be a good time to review some basic investing tenets. As always, we are here to answer any specific questions regarding your unique circumstances.
How to Survive a Bear Attack (An Ode to Leo)
Why Dividends Matter and Why Increasing Dividends Count Even More
It is important to remember that the payment of a dividend is not necessarily a good thing, in and of itself. It is a taxable event for non-qualified accounts in which the company gives a piece of itself back to the investor to spend, invest elsewhere, or put back into the company paying the dividend, typically via a dividend reinvestment plan.
If, for example, a company is paying a $1 dividend and is trading at $50 per share, the stock will drop by $1 per share to $49 per share on the ex-date, barring additional market movement. Once the dividend is paid, the investor’s account contains $49 worth of stock and $1 worth of cash, the $1 distribution being taxable. Your $50 of stock before the dividend payment is now $49 of stock, $0.85 of cash and $0.15 in the pockets of the IRS for those in the 15% dividend tax bracket. Doesn’t sound like such a great deal now, does it? So why do you hear commentators praising dividends – in general terms, or the reinstatement thereof - as has been trumpeted lately for banks?
Clearly it is the company’s ability to pay - and keep paying - dividends that matters, since ultimately there is a direct correlation between ever-increasing dividends and ever-increasing earnings, the latter of which leads to ever-increasing stock prices over time. Management that knows it has to write a big check to shareholders every ninety days - and a bigger check every 365 days for those companies that consistently increase their annual dividend payments - will create a culture in which increasing earnings are a priority. In order to fulfill this mission, dividend-paying companies tend to outperform the market over time because management has this extra incentive to exercise financial discipline that favors stockholders. Cutting a dividend is paramount to admitting failure, and these companies have set their bars high.
Let’s look at the example of Boeing, Inc. (BA) as evidence of the long-term correlation between dividends, earnings, and stock price. Over the ten-year period from 2006 to 2015, BA increased its earnings at an average rate of about 10% per year. The annualized percentage gain in BA dividend over the same period? Surprise, surprise, just over 11%, from $1.20 per share in 2006 to $3.64 per share in 2015. (The payout ratio, or dividends divided by earnings, fluctuated but only exceeded 50% in one year and otherwise held steady in the 30% to 50% range). These figures show the strong, long-term correlation of earnings and dividend growth for companies which increase their dividends consistently over time.
Whether you need dividends to satisfy short-term expense needs or have a goal of material future income, dividend paying stocks - which both tend to outperform their non-dividend paying brethren while at the same time being less volatile - are a great core holding for any equity portfolio.
Scott Kyle, CEO/Chief Investment Officer