When I write an article that mentions the benefits of owning blue-chip American stocks that pay dividends, I hope that I do not give the impression that dividend growth investing is a strategy that comes with little flexibility. While it can be quite wonderful to make a stock investment that grows its earnings and dividends by 7% or more almost every year, there is nothing to prevent long-term investors from using discretion to take advantage of the opportunities in the marketplace created by the excessive greed, fear, or folly of the stock market participants.
For me, one of the major selling points of dividend investing is that it grants investors a viable course of action regardless of whether the price of a given stock is overvalued, fairly valued, or undervalued.
Let's take a look at the 2007/2008 Highs and 2008/2009 Lows for some of the most stable blue-chip stocks that pay dividends: Johnson & Johnson (JNJ), Exxon Mobil (XOM), Coca-Cola (KO), PepsiCo (PEP), Procter & Gamble (PG), Colgate-Palmolive (CL), Chevron (CVX), and Abbott Labs (ABT).
If you own high-quality blue chip stocks that pay dividends, you have a lot of options as the pricing environment shifts. Let's begin with the decisions that you could have made in 2007. When Chevron was at $104 and Pepsi was at $79, you could have followed Benjamin Graham's legendary advice that "the stock market is there to serve you, not instruct you." You could have concluded that both companies were overvalued, and you could have reaped the benefits of advantageous pricing by locking in a gain and looking for better priced alternatives.
Or, you could have sat there and thought, "Well, both of these companies are best-in-breed and have grown earnings at over 10% annually since 2000, and therefore, I am going to go about my business as I receive the growing income checks in the meantime." It can be somewhat of a win-win. Yes, if you took advantage and sold out of Chevron and Pepsi before the stock market crashed in 2008/2009, you could have maximized your wealth through market timing.
However, that approach is hard to implement successfully without the benefit of looking back and identifying the highs and lows. It's much easier to identify an excellent company, and then continue to hold it throughout the fluctuations in the marketplace. The Chevron and Pepsi investor that declined to sell out in 2007 and has still done quite well for himself. Over the past five years, Chevron has grown earnings by 6.5% annually and dividends by 10.0% annually. Pepsi has managed to grow earnings by 8.00% and dividends by 13.5% over that same time period. Considering that no skill is required to receive those benefits other than identifying that Chevron and Pepsi were great companies in the first place, that's not a bad deal.
And, of course, the other side of the coin is when Mr. Market chooses to value companies at a rate that is well below intrinsic value. It may seem crazy to believe now, but Johnson & Johnson traded around $46 at its 2008/2009 low, and Coca-Cola traded at just shy of $19 on a split-adjusted basis. The great thing about a dividend-focused strategy with blue chips is that you're often provided with higher dividends during the market lows of the recession that can make it much easier to find the gumption necessary to avoid selling at the worst moment. Johnson & Johnson raised its quarterly dividend from $0.415 per share to $0.46 per share in 2008. From 2008 to 2009, Coca-Cola raised its dividend from $0.19 to $0.205 per share quarterly. If you focus on the dividend growth, and the earnings power that underlies it, it is much easier to ignore the quotes offered by Mr. Market when he is trying to rattle your nerves.
A simple way to practice a dividend-focused strategy is to identify an excellent company, purchase it at a reasonable price, and then monitor the earnings and health of the business as the larger dividend checks roll in each quarter. But this strategy comes with advantages when Mr. Market engages in extreme acts of greed or fear. During the market lows, dividend-paying companies allow you to reinvest at lower prices, so that you may reap a tangible financial benefit when the stock price recovers. And when Mr. Market gives you a price that is above what the company is worth: you may choose to take advantage of the situation by selling the overvalued stock and redeploying the funds into an undervalued security, or you can ignore the price and continue to build wealth as the earnings and dividends continue to grow. A dividend-focused investor can do quite well without responding to the prices offered by Mr. Market, but he is certainly free to take advantage of the folly by reinvesting the dividends at market lows or selling overvalued dividend stocks at market highs.