David Fish provides investors with an invaluable service by maintaining an updated database of “Dividend Champions,” “Dividend Contenders” and “Dividend Challengers.” The database consists of stocks that have increased dividends by 25-plus years, 10-24 years, and 5-9 years, respectively.
Unfortunately, too many investors derive the wrong conclusions from examining resources like this. For example, it has become clear from my experience that many investors have been tempted to conclude that if they simply buy and forever hold stocks such as this with a track record of consistent dividend payments and dividend growth that they will be able to enjoy “dividends for life,” on a road to stress-free riches.
There are two important reasons why such complacency constitutes a serious error.
Survivorship bias is a type of logical error that involves analyzing the performance of a sample of subjects that have “survived” a given selection process over time, to the exclusion of those subjects that did not survive the selection process over the same period of time. The fallacy occurs because the “non-survivors” no longer exist or are otherwise not visible.
This sort of logical fallacy can lead to false and/or misleading conclusions. In particular, survivorship bias in financial analysis tends to lead to unreasonably optimistic beliefs about particular groupings of stocks that have been selected or “screened” based on certain criteria because the failed members from the original grouping that met the selection criteria are ignored.
The danger of committing this sort of logical error when contemplating a list of stocks such as the Dividend Champions is quite acute. Indeed, I have observed that many investors have a tendency to look at such a list and conclude that it is “easy” to make money purchasing dividend stocks and holding them “forever.” Many are tempted to reach conclusions such as: “If I had simply purchased these stocks or a selection of these stocks 25 years ago, I’d be rich today given the dividends, dividend growth and capital appreciation of these stocks. And the best thing about this sort of investing is that one can sleep easy at night and not even ever have to worry about these stocks at all. All one has to do is rake in the dividends and wait to get rich.”
This sort of reasoning is faulty. The problem with this analysis is that it omits the fact that when a person looks at the Dividend Champions list of today, they are only looking at the survivors, or “winners” such as AT&T (NYSE:T), Coca-Cola (NYSE:KO), Colgate-Palmolive (NYSE:CL), Exxon Mobil (NYSE:XOM), Kimberly-Clark (NYSE:KMB), Consolidated Edison (NYSE:ED), Pepsi (NYSE:PEP), Procter & Gamble (NYSE:PG), McDonald's (NYSE:MCD) and Wal-Mart (NYSE:WMT). They are failing to see the “loser” companies that would have been on the list that they actually would have had to choose from 25 years ago and that fell by the wayside either because they cut dividends, canceled dividends, or even went bankrupt. When investors see the list today, they are not seeing former dividend Champions, Contenders and Challengers such as Enron, Xerox (NYSE:XRX), Lehman Brothers, Bank of America (NYSE:BAC) and other (at-that-time) steady and reliable dividend-paying “blue chip” companies that crashed and burned.
In this regard it is instructive to look at the companies that have fallen by the wayside in the roughly 3.7 years since this database has been kept. According to the data provided in the “changes” section of the database, 134 companies have been deleted from the database due to dividend cuts, dividend cancellations, corporate transformations or other problems. There are a total of 452 survivors.
Thus, more than 29% of the companies that would originally have comprised the database 3.7 years ago have fallen by the wayside for any number of reasons that would have required investors to have made some difficult and even agonizing choices regarding what to do – e.g. sell or hold at a loss after a dividend cut or cancellation, remain invested in an acquiring company that was not a dividend champion, etc. The 29% figure actually understates the percentage of companies that would have required difficult active management decisions by investors since a number of companies were added to the list since its inception.
Now, the exercise above was performed with only 3.7 years worth of survivorship data. Now imagine what would happen if we examined what happened with an original list of dividend champions, contenders and challengers from 25 years ago. I do not know what percentage of companies would have gone by the wayside, requiring difficult active management decisions. However, from familiarity with various studies on survivorship and by examining the internal composition of the current list, one can quite safely conclude that more than 80% of the original list would have gone by the wayside, requiring active management decisions on whether to dispose of the company from the portfolio, remain invested in an acquiring company and etc. In fact, only the 101 currently reigning “Dividend Champions” from an original list of perhaps 500-700 stocks promising “dividends for life” 25 years ago would have survived the test of time. And a very high percentage of those that did survive have undergone corporate transformations including mergers and acquisitions that also may have required difficult active management decisions.
There is no free lunch. Even when times are good.
The End of the Great Moderation: The Demise Of Reliable Dividends
When we look at a list of companies that have raised dividends for 10, 25 or more years we need to take into account that these companies have benefited from having lived through an extraordinary era of economic stability and prosperity dubbed by economists as the “Great Moderation.”
The Great Moderation is generally dated to have begun in 1985 and to have ended around 2008. During these 23 years the rate of real GDP in the U.S. was substantially higher than its long-term historical averages. Most importantly, this was accomplished in a context of unprecedented macroeconomic stability. During this era, business cycles were much more prolonged and more stable than long-term historical norms. Furthermore, output was less volatile and unemployment was less volatile than ever before in U.S. history.
It is generally agreed among economists that such idyllic times are over. High levels of government and household debt, heightened interest rate sensitivity, unfavorable demographic trends, weakened financial systems and complex global and financial inter-linkages mean that heightened macroeconomic volatility will almost certainly be a fact of life in coming years and decades.
To the extent that this is true – and there should be little doubt that this will be the case – the corporate earnings and cash flow of all companies comprising U.S. stock indices (^SPX, ^DJIA, ^IXIC, ^NDX, SPY, DIA, QQQ) should prove to be significantly more volatile than they were between 1985 and 2008. As a result, it is inevitable that dividend payments will become more volatile, with greater frequencies of dividend reductions and/or cancellations.
Many companies that were able to maintain consistent dividends in the past 25 years due to the extraordinary stability of the Great Moderation will not be able to do so in coming years and decades.
Some have argued that companies that were able to maintain and even raise dividends through the 2008-2009 crisis have proven themselves to be essentially “bullet-proof.” Nonsense.
The 2008-2009 recession was actually quite short and quite mild by the historical standards of the past 140 years. In fact, between 1918 and 1985 there were no less than seven recessions that were of a magnitude and/or duration significantly greater than the 2008-2009 recession. If one examines the historical record prior to 1950, the average recession was much more severe than the one in 2008-2009.
Thus, the notion that the 2008-2009 recession constituted some sort of definitive test of the safety of dividends of companies that continued to pay and raise dividends throughout this particular recession exhibits great historical ignorance by those that make these sorts of arguments.
Since 1985, if less than 20% of companies that raised dividends for five or more consecutive years were able to maintain that record for 25 years, it is quite clear that in the next 25 years a much lower percentage of Dividend Champions, Contenders and Challengers will be able to do so in the future.
It has been my experience that too many (not all or even most) self-proclaimed “dividend investors” believe that successful investing is merely a matter of buying dividend-paying stocks with a long history of dividend increases and holding them forever, through thick and thin. In particular, many investors seem to be under the impression that they can confidently purchase stocks from a list of Dividend Champions, Contenders and Challengers, sit back and simply enjoy “dividends for life,” on a stress-free path to riches. This sort of thinking constitutes a dangerous delusion.
Despite having lived though the period of greatest macroeconomic stability in U.S. history, this is not how dividend investment has actually worked the past 25 years. And certainly, this is not how it will work in the treacherous years and decades ahead.
Survivorship bias and a biased sampling period encompassing the Great Moderation have contributed to the spurious belief that dividend investing has provided in the past and will provide in the future an easy path to security and riches.
Most experienced and successful dividend stock investors will testify to the fact that their craft is actually quite difficult and taxing. Indeed, very few people are cut out for this sort of work, either intellectually or emotionally.
Furthermore, I would submit that even the most experienced dividend investors today are ill-prepared for the challenges that face them in coming years. In the vast majority of cases, these investors have mainly lived through the “Great Moderation.” Few dividend investors have ever had to deal with the sort of macroeconomic volatility that characterized the U.S. economy historically and which is likely to characterize it in the future.
As I intend to show in my continuing series on the subject, astute market timing and skillful stock selection will be fundamental prerequisites for investment success in the coming years and decades. The “easy years” of steady earnings growth, consistent dividends and continual multiple expansion enjoyed during the Great Moderation are over.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.