Picture this. You've just finished running a marathon. You haven't had a drink of water in the past five miles, and your throat is parched. As you walk through the finish line, someone hands you a drink. Looking at the clear liquid that you presume to be water, you greedily take a big gulp and then realize: oh no, it's tequila.
That's how I feel every time I read an article that talks about the performance of a given stock or index over time without including dividends, as if dividends are this optional consideration that can either be included or not, like putting a slice of cheese on a hamburger. The St. Louis Post-Dispatch ran a financial column titled "Stocks Quickly Went Nowhere in 2011" that mentioned: "The S&P 500 Index of big companies ended the year flat, down a mere 0.003%...Profits rose 12% at big companies while stocks were going nowhere."
Kim Peterson of MSN Money recently wrote: "So where are investors putting their money? Savings accounts, bank CDs, and money market funds that earn less than 1%, Reuters reports. They're paying dearly for safety, and they don't mind one bit. That kind of return starts to look a little better when compared with the 0.04-point drop in the Standard & Poor's Index in 2011."
Peterson's decision to not include the presence of dividends in her analysis appears to be particularly striking since the strength of her argument points to the superior returns of "near 1%", when in reality, the 2% dividend of the S&P 500 would have delivered a better return than those saving accounts mentioned in the article.
A few days ago, fellow Bruce Springsteen fan Rocco Pendola mentioned this about the effect of dividends on his portfolio: "Collecting the quarterly dividend on my 153.7 shares of Verizon (NYSE:VZ) tacked on two free shares and turned a 0.3% loss into 1.0%."
In Rocco's case, including the calculation of the dividend is the difference between losing and making money so far on an investment.
It's easy to just look at the superficiality of a stock price and believe that this overwhelmingly speaks to the total return of the stock, but it can be quite misleading and inaccurate. For instance, AT&T (NYSE:T) currently trades at $30.23, and that's a price you could have paid for shares of the company in early 2006. However, the company also paid out $1.33 in dividends in 2006, $1.42 in 2007, $1.60 in 2008, $1.64 in 2009, $1.68 in 2010, and a $1.72 in 2011. That's $9.39 per share in total dividends during that time frame. If someone bought 100 shares of AT&T in 2006 for $3,023, a superficial analysis might indicate that nothing much has happened; after all, those shares could be sold for $3,023 today. However, the reality is that the owner of AT&T stock would have collected $939 during that time period, giving the investor a nice 31% gain from 2006 to the present.
I do think though that the decision of some financial professionals to ignore dividends altogether is a symptom of a larger problem. There is a certain "invisibility" aspect to dividends that can make them easy to ignore or underestimate (What's the big deal, it's just a percent or two, right?). After all, capital appreciation is something that is so much easier to calculate. You can look at what Apple (NASDAQ:AAPL) was trading at 5 years ago, compare it to today's price, calculate the difference, and then arrive at the performance of the investment. But if you're looking at the 10-year performance of Johnson & Johnson (NYSE:JNJ), you have to go through the trouble of adding up ten years of dividends to determine the true performance. It can be a convenient thing to ignore, and that is a shame, because the first step to creating a plan to live off the income generated from investing comes from recognizing how potent those 3%-4% yields with annual raises will become over time.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.