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Summary

  • Critics point out that Southern Company may only grow profits 3-5% annually.
  • Despite this, Southern Company has a long track record of turning low growth into 8-10% returns.
  • Southern's total returns will trail the S&P 500 going forward unless you reinvest dividends.

Southern Company (NYSE:SO) is one of those companies that is easy to ignore when building a long-term portfolio. After all, the stock price never seems to do anything: the stock traded in the $30s every single year from 2003 through 2011, and as of Friday's close, the price sat at $42.92. Over the past decade, the price appreciation is only a little above 30%, perhaps not particularly appealing when you're trying to create a collection of assets that will increase your purchasing power.

Even tallying up the dividends over the years doesn't make Southern Company look particularly appealing in comparison to a plain vanilla S&P 500 index fund. Check out this chart of Southern Company vs. the S&P 500 over the past twenty years without any dividends reinvested.

Southern delivers 6.9% annual returns while the S&P 500 delivers 8.6% annual increases in performance. It took two decades to get your yield-on-cost up to 10% with Southern Company, while the S&P 500 would have given you an extra $12,000-$13,000 in unrealized wealth that could have been converted into cash if you sold this past Friday.

From these perspectives, Southern Company looks like a substandard asset: the stock price appreciation has not been substantial, the annual dividend growth generally matches the inflation rate at a 3% or 4% level, and someone that buys the S&P 500 would have a lot more paper wealth than someone focused on collecting dividend checks from this Georgia, Mississippi, Florida, and Alabama electricity provider.

But funny things start to happen when you take relatively large dividend payments (even from a slow grower) and plow them back into the dividend-paying asset, allowing the process to repeat 80 times over the past decades.

Now, take a look at what happens to Southern Company's performance when you compare it to the S&P 500 over the past two decades with dividends reinvested.

Now, Southern Company, which only grows its earnings and dividends by 3.5% annually for the past two decades, is suddenly on par with the S&P 500. The yield on cost over the past two decades is on the verge of hitting 25%, entitling you to a cash return of $6 every ninety days for every $100 you put into Southern Company twenty years ago.

For people that plan on living off the fruit of their investments rather than selling their assets to make ends meet, Southern Company is suddenly fulfilling a very valuable role: while $10,000 invested in the S&P 500 twenty years ago would be paying you $1,047 per year in annual income, Southern Company investor would be collecting $2,500+ in annual income. Do that two or three dozen times in your life, and you'll join the financially independent class.

The astute among you might be wondering: Why'd I spend time sharing that story with you, and what does that tell us about Southern Company as an investment going forward?

To answer that first question, it's important to understand how those seemingly paltry 4% or 5% annual cash payouts can lead to drastically different results than someone studying a price chart or a profit growth chart would anticipate. The price of the stock only averages increasing 4% annually over the long term, and the business performance only increases at a 3-5% annual rate, which manifests itself on a dividend growth rate in the 3-5% as well over the long time. Despite seemingly unimpressive price, business, and dividend growth, the stock returns 9% annually when factoring in the reinvested dividend. That's nice knowledge to keep in the back of your pocket.

Now, to answer the question I posed: Why does that matter for Southern Company going forward?

Because it demonstrates that even though Southern Company has some very real business headwinds facing it going forward, you can still achieve total returns in the 8-10% range even though it appears the business is only going to grow at a 3-5% pace for the next five years or so.

At Mississippi Power, the company had to deal with high-cost write-downs of almost $800 million. The nuclear construction projects in Georgia could potentially cause similar problems, and plus, the investments there won't actually start increasing Southern's profits for 4-5 years. Additionally, Southern has had trouble getting meaningful rate increases from its Alabama, Florida, or Mississippi services (only Georgia regulatory authorities have been giving Southern rate increases lately in a way that will actually add more than tens of millions of dollars to the company's earnings power, which currently rests at about $3 billion per year).

If you're an investor that is typically attuned to looking for growth catalysts for making investments, then Southern isn't something that looks particularly appealing. It seems like all of its construction projects cost materially more than originally allotted, the volume growth and overall rate increases don't even allow optimistic investors a way to envision earnings per share growth in excess of 5% annually.

What's worth keeping in mind, though, is that Southern Company has followed this path before (that is, 3-5% annual profit and dividend growth), and over the past two decades, this has managed to translate into 9% annual returns due to the reinvestment of a dividend that is usually about 3x the rate of the S&P 500. Do I think this stock is a screaming buy? No, I don't. But I also don't think the doom and gloom predicted about its future performance is correct either. I understand why investors are concerned about its future profit growth, but the company has a long-term record of taking 3-5% growth and turning it into 8-10% total returns, once you include the reinvested dividends. Even if the future growth is unimpressive, the returns that you the investor receive ought to be at least satisfactory, with much higher income than what you'd get by picking up a fund that tracks the S&P 500.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Southern Company: Reinvesting Dividends Is The Key To Wealth