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)
Own dividend paying stocks. Nearly half of all the S&P 500 returns have come from dividends over the last 40 years. When you own high-quality dividend paying stocks, you can sleep at night knowing that at least about half your profits are secure. Having a steady source of incoming cash also lessens your likelihood of selling your stocks at the wrong time. During bear markets, dividend paying stocks tend to go down less than the overall market/than growth stocks with high P/E ratios. To the extent you don’t need the income in the near term, the reinvestment of said dividends leads to more share ownership and higher future income – plus capital appreciation – once stocks recover. From 1969 to 2014, the S&P 500 with reinvested dividends grew to over 4 times that of the same portfolio without dividends reinvested. 4X… that is eye opening.
Engage in things in life that take your mind off of what may be (but shouldn’t be) stress inducing day to day stock price movements. Go workout, start a new hobby, call a friend, meditate. Things that are positive for you and occupy your time will make you less inclined to track day to day market vacillations – and generally make you a happier person.
Review statistics around how long bear markets typically last – and compare this with your actual investment time horizon. The average bear market lasts just over a year. I’ve had clients who are 10 years from retirement (with a need for the money to work for them another 20+ years beyond their retirement date) express fear over near-term stock price declines – even though in reality by reinvesting dividends they will be financially better off in 10+ years by virtue of stock price declines today. Be very realistic about your true investing time horizon. Remember, a stock yielding 4% today can have an effective yield (income divided by original purchase price) of double digits in 10 years between reinvested dividends and annual dividend increases.
Review facts around how attempting to time the market statistically will likely make you poorer than if you maintain a disciplined approach. There are countless studies showing empirically that the probability of attempting to time the market leading to far worse returns than holding a steady course is high – even for those who dedicate their lives to timing markets, let alone those who have professions outside of money management.
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.