There is an old saying on Wall Street… “Profits are a matter of opinion, but dividends are a matter of fact.” As we are coming up on a decade long bull market that is coinciding with a massive tax cut for corporation, this saying carries even more weight… especially to dividend thirsty investors. Quite simply, they want to know what these companies are going to do with all these profits! And for good reason, how much will be paid out in dividends!
You see, historically, dividends have a powerful impact on investment performance. Various research shows over a 20-year period, dividends account for 60% of a portfolio’s return. An amazing statistic when you consider so many investors are focused on the next great growth company and the majority of growth is right under your nose… in some old stodgy company that’s been paying a dividend for decades.
At the end of the day, as investors, we track our success by performance. So, the financial impact of dividends is of utmost importance. But dividends can also give a powerful signal of what type of company you are investing. There are three clear signs of a financially strong company derived from their dividend related activity:
· The length for which said company has been paying a dividend. The longer a company has been paying a dividend the more confident you can be they will continue to pay it in the future.
· The consistency with which a company raises their dividend. As companies are in the business to grow their profits they also raise their dividends (many times matching the profit growth).
· Maintaining a dividend payout rate (the % of profits paid out in dividends) that is acceptable even in a poor economy.
When a company has a history of paying an increasing dividend it tells you that management gets it! They understand that has a shareholder you have a right to the profits of a company and if management cannot properly reinvest these profits back into the company to achieve an acceptable return they should consider paying a dividend.
In addition, a consistent dividend keeps management financially disciplined. You see, because having to lower a dividend or suspending it is, well, not good. In the end, this makes for an even better run company investors will have confidence in and ultimately resulting in a great long-term investment.
Lastly, a wise colleague once told me, “Don’t complicate things… growth is growth. It doesn’t matter if it comes from stock price appreciation or dividends.” And since all investors share this singular goal of growing their capital, don’t lose sight of the power of dividends in achieving this goal!