- Stock price growth and dividend growth, while related to earnings, are mutually exclusive investment events.
- Just because a company pays a dividend does not mean it has less earnings power than a non-paying peer.
- Dividend growth is a more concrete way to survive retirement than relying on the 4% rule.
- There is forward value to focusing on the dividend producing capability of a company.
Though I am not a totally focused dividend investor, I believe that there are many investors who stand to benefit from a dividend-focused strategy. This opinion is somewhat of a rebuttal to a portion of Dale Roberts' recent article on dividends.
I agree with Dale that earnings power drives growth, which usually reflects itself in stock price appreciation and/or dividend growth. However, stock price growth and dividend growth can be mutually exclusive elements of the investor experience. One does not necessarily experience stock price growth when one sees dividend growth.
Stock price growth is simply a product of the laws of common share supply/demand, and while there has been a historical correlation between stock and earnings growth appreciation, it is a correlation that bears no guarantee.
Dividends, on the other hand, are actually predicated on earnings and/or cash flow generation to underwrite the payment. So dividends, as I commonly opine, are a convenient way for a company to return periodic profits to investors and a way for shareholders to lock them in. And though they are not guaranteed either, one generally has a better idea of what their dividend will be in three months as opposed to where their stock's price may be.
Assuming that share price growth will continue puts portfolio profits at the mercy of the laws of supply and demand, and somewhat less on a company's forward earnings growth. Mr. Market does not always send a stock's price up when its earnings go up.
Comparing Apples To Oranges
Dale offered a comparative analysis on orange harvesting operations as an example of reinvestment in a business versus distributing part of the profits to investors. His analogy inferred that the operation that distributed oranges periodically to shareholders (paid a dividend) was in an inferior position to grow the business going forward. I found that analogy very simplistic since it didn't take into account any of a wide variety of real world variables that might affect corporate bottom lines. Just because a company has a bigger asset base, makes more investments, or does not pay a dividend doesn't mean that it will grow its bottom line any faster than one with less assets or a more conservative strategy.
Forgetting about oranges, I did agree with him that when comparing investment options, one wants to partner with companies/securities that offer "the greatest potential to provide earnings and money to spend in future years." Although I would probably augment the statement to say "the greatest potential to provide earnings and money to spend and/or share in the future."
Who Wants To Be A Retired Millionaire?
Dale later stated during his article, "But we should also realize that there is no need to chase yield in retirement." While I would also recommend avoiding a yield "chase," I would argue that "pursuit" of yield is not a faulty notion.
If a new retiree with a million dollar nest egg goes in with all growth stocks under the premise of the "4% rule," what happens if we experience a 25% sell-off in stocks soon after retirement is started? In year two of retirement this person is down to $700,000 -- and all the sudden they can only withdrawal $28,000 as opposed to $40,000?
Retirement is exactly the time we want to have something more definitive to fall back on. Dividends are more definitive than stock price, in my view. Yes, companies do cut or eliminate dividends from time to time, and quarter-to-quarter payments/increases are at the mercy of a board of directors. But I would opine that the chances of a $40,000 diversified dividend portfolio being slugged down 30% to $28,000 a year are far less than the chances that a portfolio's top line value could drop 30 percent during a panic or bear market.
Thus, I'd rather take my chances with dividends rather than supply/demand price economics in retirement.
Focusing On Dividends
Dale stated, "Dividends have nothing to do with the company's ability to create value or earnings." Mostly true, although I'd contend that a dividend represents value for an investor who seeks an income stream. But just because dividends don't create anything does not mean there is not value in analyzing them. In a recent article on the risks of dividend growth investing, I discussed the importance of the payout ratio, starting yield, projecting forward dividend growth rates, and cash positions.
Investors have the ability to extract value by investing in companies that have cash rich, clean balance sheets with low payout ratios. Such companies may be able to offer dividend growth well in excess of earnings growth and stock price growth. If I were in retirement, I'd want to exploit a company for every dividend hike I could. Increase the payout ratio -- stock price be damned!
While that may be a bit melodramatic, I strongly believe that retired investors, who could end up living much longer than any 4% rule might predict, should have a good portion of their assets in dividend growth stocks.
There's nothing magical about a dividend, but there's certainly nothing scandalous about one either. There's sound rationale as why one would, or even should, focus on dividend paying stocks or engage in a dividend growth focused strategy. Stock prices don't always go up; in fact, they can go pretty far down. Dividend investing represents a concrete, logical way to hedge stock price risk, conveniently locking in profits at the same time.
Additional disclosure: Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.