“Dividends” Are An Investors Best Friend

In 1994, my first child was born and I felt the need to buy her a single stock certificate. It just felt like a cool thing (maybe lame, I don’t know) to do when you have so many dreams for your daughter. The lesson over the last 24 years has been priceless – dividends are the investors best friend!

In 1995, I purchased 1 share of Merck for ~$10, framed the certificate, and hung it in my daughter’s room. A few months later, we got a $0.15 check mailed to our home address. My wife took that check to the bank and deposited it in our checking account.

But the “annoying” checks kept coming every 3-months. So we finally wised-up and had them deposited directly into our checking account. (NOTE: If I was really smart I would have reinvested those dividends back into the stock) Today, we still have that stock certificate and those annoying $0.60 annual deposits are now paying $2.20 per share annually.

Let’s put this in perspective … 24 years after purchasing that 1 share of Merck stock for $10 and I’ve received over $36 in dividends. I’ve more than tripled my money in 24 years on dividends alone. And within 10 years, I received over $10 in dividends so I had already received 100% of my money back. And I didn’t even reinvest those dividends which would have compounded those numbers even higher.

Dividends

My Merck story easily explains just how simple crazy it is to receive increasing dividends without doing anything. And all based on wanting to hang a picture of a stock certificate on a wall. I should have bought 1,000 shares versus just one and built an entire portfolio of these types of companies. This is a lesson both my daughters are learning from their dad.

Briefly – What is a dividend?

Let’s level set and keep it simple in defining dividends. Dividends are a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. They are usually paid quarterly but monthly, semi-annual, or annually can occur too. If you want to learn more about dividends you’ll find thousands of articles on the internet.

Approximately 422 (84%) of the 500 stocks in the S&P 500 pay a dividend. During this stage in their life cycle, most companies (i.e. 84% in the S&P 500) start rewarding shareholders with cash dividends on a portion of company profits.

The benefits to shareholders can be significant too. In a taxable account, qualified (versus non-qualified) dividends may receive some tax advantages. Assuming your dividends are growing over time, they can hedge against inflation. Dividend paying stocks and the income they produce can also help buffer your portfolio during downturns.

The dividend income can either supplement your income or be reinvested into buying more stock. Dividends can really boost your total return and provide some tremendous calm when the markets look scary.

The Power of Dividends

Buying strong companies (i.e. balance sheet, earnings growth, lots of cashflow) will help you build wealth. Buying those companies at the right price will create more wealth. If you add in the power of dividends, especially dividend reinvestment, then you will win. It’s safe to say that it’s really that simple.

Look at the chart below and soak in the beauty of the S&P 500 rewarding shareholders that reinvest dividends. Can it be that simple? Buy quality companies, reinvest their dividends, and don’t sell. Let the dividends reinvest in buying more stock over the years.

Data Sources: Morningstar and Hartford Funds, 1/19

I think it’s that simple. It’s the reason for creating the Master Stock List (it’s still growing but 41 stocks is a place to start). 39 of the 41 stocks on the list pay dividends. And I’m waiting patiently to purchase them at the right price. And I’m reinvesting the dividends to compound the growth. These are my buy and hold stocks that will likely never be sold.

So how important are dividends? The chart below shows that from 1930 through 2018, dividends contributed 43% of the S&P 500 total returns. Can you imagine not having those returns added to your portfolio? The difference can mean someone retiring at 55-years old or 65-years old. In other words, it’s significant and you need them in your portfolio.

Data Sources: Morningstar and Hartford Funds, 1/19. *Total Return for the S&P 500 Index was negative for the 2000s. Dividends provided a 1.8% annualized return over the decade.

Conclusion

It should be no surprise that all but two of the companies (Berkshire Hathaway and Google) on my Master Stock List pay a dividend. I’m reinvesting those dividends to by more stock. Each quarter, I receive an additional 4 shares of AT&T and 2 shares of Exxon because I’m reinvesting the dividends. And when the time is right, I’ll start taking those dividends as cash to supplement my retirement.

Here’s the cool thing about dividend reinvestment … I can start and stop the process at anytime. If I don’t need the income then I will likely keep reinvesting some or all of the dividends. And let’s not forget, the dividends aren’t guaranteed. But if you choose the right companies then it’s very likely that your dividends will at least be paid (if not grow).

My only regret is that I didn’t start doing this when I was younger. And one final thing to add about my dividend stocks. Quality companies plus dividends has brought calm to the TLR household during the recent market volatility. That calm is priceless to an investor.

Thanks for reading!

Mr. TLR