Dividends Making A Comeback

Includes: BRK.A, BRK.B, MCD, UNP
by: Sean Weston

Dividends are one of the oldest and most consistent signs of a company's financial health that investors have had throughout history. For much of the period before new acts of legislation were implemented in the 1930s requiring the disclosure of financial information, dividends were one of the main and only items an investor had to examine a company's financial health. Even now, after more fundamentals and metrics are available for investors due to increased transparency, dividends remain a very important measuring stick.

Dividends cannot be "faked" in the way that other financial statistics can be. Accounting tricks are available and frequently exploited by many firms. These allow them to embellish earnings-per-share numbers, hide debt through off-balance sheet actions among other events. With dividends what you see is explicitly and unambiguously what there is, and what you get.

The dividend yield of the S+P 500 is currently slightly over 2%, well above the historical minimum since 1871 of 1.11% during August of 2000, but substantially below the mean of 4.44%. Nevertheless, it has been on a pretty consistent rise since 2000. One of the reasons why that year was so low was because of the wealth of tech stock IPOs, which were created during that era, rarely paying a dividend, and the fact that it became fashionable for companies to claim they were better off keeping the money as retained earnings rather than paying them out as dividends to the shareholders because they could generate more value for shareholders that way.

While true in theory, this is often a point of view used a bit condescendingly with shareholders, a "daddy knows best" attitude. And it more often than not does not work out this way, as investors would soon find out. Gaining their collective voices after years of watching their portfolios stagnate, "more dividends" is a very popular shareholder wish these days.

Some rare, prudent individuals like Warren Buffett with his Berkshire Hathaway (BRK.B,BRK.A) of course, are a notable exception. With gargantuan cumulative returns for his shareholders since 1965, he has returned them value, despite the fact that this was done without dividends.

Even in the case of Buffett however, it should be noted that some Berkshire shareholders have voiced their opinion that in light of Berkshire's share price for the last decade not moving up at the pace long-term shareholders have been accustomed to, they would like to see a dividend from the company. Despite these voices, I don't think Warren Buffett is likely to capitulate in this area.

It becomes a harder task to create worthwhile enough value to justify not paying out dividends as a company increases in size. As Buffett himself states, it becomes harder and harder every year and he would be able to accomplish it much easier if his company were 1/100th of its current size. For a defensive, more conservative investor, large-cap stocks are usually what is involved in their stock selection. The fact that someone whom many people state is the greatest living investor admits to this should probably lead investors towards siding with dividend-paying stocks; which for the record Buffett does with his own investments for Berkshire, which are overwhelmingly comprised of dividend payers.

The returns of Buffett's company are a substantial achievement considering that since 1931 dividends have accounted for over 40% of the return for large-cap stocks in the U.S. and accounted for over 100% of the return for our last completed decade. During decades of extremely low capital appreciation, as the 2001-2010 decade was, the existence of dividends becomes even more important. There have been three decades in which dividends account for a greater portion of the index's return than capital appreciation:

Dividend Contributions to S&P 500 Returns by Decade

















While much talk is made about "lost decades" in investing, being near or completely absent of capital appreciation, that isn't the case if you make investments in solid companies with substantial yields and reinvest those dividends. In actuality, this is more beneficial to the long-term investor.

Many times after one of these lost decades, the following decade produces above-average returns for investors in the form of capital appreciation. However, this is not a given, it is not a law, as past results can't neatly be extrapolated and applied to the future. Investors should take nothing for granted and still persist in popularizing the call for increased dividends.

Two companies that appeal greatly to me with their recent dividend activity are Union Pacific(NYSE:UNP) and McDonald's(NYSE:MCD). McDonald's is a bit more conservative of the two, with Union Pacific being a bit more cyclical in nature. Over the last seven years Union Pacific's dividend has increased a total of 415%, and McDonald's 287%.

Union Pacific
Year Dividends Paid Per Share % Increase From Prior Year
2012 2.49 29%
2011 1.93 47%
2010 1.31 27%
2009 1.08 10%
2008 .98 31%
2007 .75 25%
2006 .60
Year Dividends Paid Per Share % Increase From Prior Year
2012 2.87 13%
2011 2.53 12%
2010 2.26 10%
2009 2.05 26%
2008 1.63 9%
2007 1.50 50%
2006 1.00

Union Pacific's large increases come after three years (2004, 2005, 2006) in which there was no dividend change whatsoever from the company. Since then, we've seen from the company multiple dividend increases within the same year. McDonald's on the other hand is a member of the S&P 500 Dividends Aristocrat Index, meaning for at least the last 25 years it raised its dividends. Not only that, but among that elite class of dividend aristocrats, McDonald's is near the top of the heap when it comes to those growing their dividend the fastest.

An important time frame to look at when viewing a company's dividend history is during our recent crisis of a few years ago. Staples of the Aristocrats, notable companies such as General Electric (NYSE:GE) were forced to be removed from the list after it cut its dividend in 2009. Increased dividends during that intense mess of a situation sent a big message to people. Particularly in the case of Union Pacific, which unlike McDonald's is not on the aristocrat list. After all, it was only a few short years ago, in better times for the overall economy, where it didn't raise the dividends for a few years. Cutting the dividend, or at the least not raising wouldn't have set the same shockwaves through the financial world had McDonald's been the one to do it.

Also, many companies in an attempt keep their streak of years of dividend increases alive during tough times will implement a 1 cent increase over the prior year, so while not substantive, technically their streak is alive. Not so with McDonald's, which went above and beyond what it had to do to maintain the streak. It sends a very important signal to investors.

There are some extenuating circumstances that can arise, which make falling dividends not necessarily a deal breaker, and rising dividends in and of themselves are not indicative of a company worthy of investing in. But they are an excellent sign and starting point into looking further at potential investments.

Disclosure: I am long MCD, UNP. 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.

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