Cash Generating Stocks Have a Long History of Favorable Returns[ii]
There is a large body of academic research that shows a long-term historical trend of dividend stocks beating non-dividend stocks.[iii] There are several reasons that dividend stocks, as a whole, tend to do better. Let’s look at each, individually.
1. Cash paying dividend stocks often have higher quality earnings.[iv]
David Einhorn's Greenlight Capital returned -2.9% in the second quarter of 2021 compared to 8.5% for the S&P 500. According to a copy of the fund's letter, which ValueWalk has reviewed, longs contributed 5.2% in the quarter while short positions detracted 4.6%. Q2 2021 hedge fund letters, conferences and more Macro positions detracted 3.3% from Read More
The accounting profession requires a lot of estimates. In the short term, it can be easy for management to make profits on the income statement appear higher or lower than they actually are.
The practice of lowering record earnings one period through the use of accounting methods, only to reverse those conservative estimates during a poor period, had at one time been almost common.[v] Seeing through to the business reality can be difficult if you aren’t aware of the techniques needed.
That is where cash dividends come in. One thing you cannot fake is cash. When a company mails you a check, that money is yours. It can be fairly surmised that companies with a long history of regularly increasing dividend payouts are, in fact, making money.
2. Dividend yields can support a stock during market corrections. [vi]
During major stock market meltdowns, strong dividend stocks tend to hold up much better than non-dividend paying stocks. The reason is due to “yield support”.
Imagine that you have two stocks, Berkshire Hathaway and Exxon Mobile. Berkshire Hathaway is one of the most financially sound companies in the world but hasn’t paid a dividend since the 1960s. Exxon Mobile is the same size as Berkshire Hathaway but pays a dividend that is about a 3.75% yield.
Imagine the stock market collapses and both your stocks are down 50%. Your Exxon Mobile is still sending you your dividends in the mail each year. That means the dividend yield is now 7.5%. If you had to sell shares, which would you give up first: Berkshire Hathaway or Exxon Mobile? Most people keep the stock that pays them dividends.
And if there are investors with cash, the odds are good they are going to be attracted to a high dividend yield, and buy shares of Exxon Mobile, putting a floor under the stock.
3. Management tends to be more discerning about spending the remaining cash.[vii]
When a firm has to send half of earnings back to the owners, it imposes discipline. It is one of the psychological restraints that are responsible for the superior returns generated by dividend stocks over long periods of time.
Charlie Munger once commented that, following his and Warren Buffett’s death, the quickest way to solve Berkshire Hathaway’s capital reinvestment risk would be to pay out most of the earnings as a dividend. The management can’t screw up what it doesn’t control.
What about High Growth Companies?
Everyone is always looking for the next Amazon or Facebook IPO, and those can be great. Yes, there have been many big winners that go on to be hugely profitable. Over the years, most of those have never paid a dividend. But do not forget that, as a group, stocks purchased at their initial offering price do poorly compared to the general market.[viii]
So don’t forget to keep your eye on the cash generating giants that “pour out money” for shareholders. It’s a wonderful thing to be sitting at home and see cash come into your accounts. If you’ve selected your holdings wisely, I believe that figure should grow significantly over the years.
It Really Does Matter
While an extra percentage point here or there may not seem like much, consider this:
An investor saving $10,000 per year, who earned 7% on his money, would end up with $4,065,289 after fifty years. A similar investor earning 9% per year would end up with $8,150,836. That extra 2% per annum meant roughly double the wealth!
Whether you own small stocks, large stocks, value, growth, international or emerging market stocks, the message is the same. On balance, you have a better chance of accumulating wealth owning a portfolio of companies that pay a dividend than if you own a portfolio of companies that don’t.
Is this all there is?
These findings apply to most situations, but not to all. A body of knowledge has been gathered through thousands of interactions with accomplished professionals.
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Common stocks generally provide an opportunity for more capital appreciation than fixed income investments but are also subject to greater market fluctuations. In addition, unlike fixed income securities, the company’s board of directors decides on the size of each dividend paid or if to pay a dividend at all.
The above materials and calculations were compiled from company reports, public filings, and other sources. While believed to be reliable, no representations of their accuracy can be made. The opinions expressed herein are solely those of the author and do not constitute an investment recommendation.
Investments and services offered through Morgan Stanley Smith Barney LLC. Member SIPC.
[i] Jeremy J. Siegel, Stocks for the Long Run” 5th Edition, McGraw hill 2015 Figure 12-2, Returns to S&P500 Stocks Ranked by Dividend Yield, 1957-2012, page 180-181
[iii] Jeremy J. Siegel, The Future For Investors, 2005, Crown Business, p.127
[iv] Jeremy J. Siegel, Stocks for the Long Run” 5th Edition, McGraw hill 2015 “Dividends and Corporate Governance”, page 133-134
[v] “Financial Restatement: Trends in the United States 2003-2012, Susan Scholz, Center for Audit Quality, P. 3-5.
[vi] Jeremy J. Siegel, The Future For Investors, 2005, Crown Business, p.142 “The Bear Market Protector”,
[vii] Jeremy J. Siegel, The Future For Investors, 2005, Crown Business, “Capital Pigs” Figure 7.1 Return to S&P 500 Firms Sorted By Capital Expenditures/Sales Rations, 1957-2003” p.106-107
[viii] Ibid, p. 85-87
[ix]Jeremy J. Siegel, Stocks for the Long Run” 5th Edition, McGraw hill 2015. Figure 12-3 Returns to S&P500 and Dow Jones Industrials and their 10 Highest Yielding Stocks, 1957-2012 page 183