Investing in dividends can be seen as the ultimate double play in the world of securities. The value of a dividend is two fold. First, the shareholder is experiencing part of the value of the company in the form of this periodic payout. Second, the investor can often rest assured knowing that the mere existence of this dividend is a great sign of the company's health. This belief is reflected in a paper published by the NYU Stern School of Business where the author writes, "some investors also use the dividend yield as a measure of risk and as an investment screen, that is, they invest in stocks with high dividend yields. Studies indicate that stocks with high dividend yields, after adjusting for market performance and risk, earn excess returns."
The regular payment of quarterly dividends indicates the ability of a company to generate earnings and this of course plays into the fundamental purpose of any corporation, which is profitability. In his 1994 publication, Stocks For The Long Run, author Jeremy Siegel explains the inherent value behind selecting stocks with dividends writing, "since the price of a stock depends primarily on the present discounted value of all expected future dividends, it appears that dividend policy is crucial to determining the value of a stock." He continues to highlight this strategy by remarking, "earnings not paid to investors can have value only if they are paid as dividends or other cash disbursements at a later date." This sentiment arises from the notion that the price of a stock reflects the value expected to be gained from the future earnings and unless these earnings are paid to the shareholder they are paying for value they may not receive.
Compounding and Payout Appreciation
The benefit of the iShares Dow Jones Select Dividend Index (NYSEARCA:DVY) is that it culls the best publicly traded dividend yield companies giving investors the dual value of healthy companies and shared earnings. At a forward-looking dividend yield of 4.15% the ETF offers a substantial increase in payouts versus the aggregate yield of the S&P 500 of approximately 2.1%. The importance of this payout is perhaps best understood in the context of an August 2012 Goldman Sachs whitepaper where the author explains, "since 1926, dividends accounted for more than 40% of the return of the S&P 500 Index. In fact, in the last decade (2000-2009), the S&P 500's total return of -9% would have been a heftier -24% had it not been for the 15% contribution from dividends." These payments also offer some protection during periods of general poor market performance, "dividend growers have historically outperformed during periods of inflation and rising interest rates." At a 0.4 expense ratio the dividend fund is an inexpensive way to rest easier while enjoying the effects of compound investing through dividend reinvestment.
Attractive growth comes not only from compounding but also when a company increases its payout as it grows. Investopia explains the power of this concept for larger players like Johnson & Johnson (NYSE:JNJ) explaining that, "if you had bought the stock (Johnson & Johnson) in the early 1970s, the dividend yield that you would have earned between then and now on your initial shares would've grown approximately 12% annually. By 2004, your earnings from dividends alone would have given a 48% annual return on your initial shares." For this magic to occur investors must have the resolve to withstand the inevitable ups and downs of a tumultuous market. It is a strategy for those who are committed and able to avoid the distractions of speculative fads that always appear more fascinating than the straightforward approach required to capitalize on compounding and payout appreciation. If that isn't enticing enough, investors would be wise to remember that, "studies show that about 40 percent of the stock market's total returns since 1930 have come from dividends."
However, dividend yields are not always a certain test of a company's capabilities. In an ABC News article titled, Dividends: Take The Money And Run, author Ted Schwartz warns, "seek dividends; don't chase them. Sometimes companies declare dividends just to get more investors now and boost share price in the short run. But down the road, investors drawn in by this may regret buying because the market punishes companies for decreasing dividends or paying them inconsistently." This is where a deeper investigation into DVY and its value can be revealing. The ETF has seen regular increases in its annual distribution by 2.54% from 2009 to 2010, by 8.52% from 2010 to 2011 and by 14.77% from 2011 to 2012. This is exactly the kind of growth investors should value in their analysis of a simple dividend solution like DVY.
Schwartz, like others, is wise to also warn investors "that investing in dividend-paying stocks is only part of an effective strategy for total investment returns from the stock market. The other part is to buy stocks with good performance records that appear to have the legs for continued success. By achieving this balance, you can position for continuing dividends and increasing value." Again, we must examine the companies within DVY to determine if their overall health is adequate for investing.
With a heavy weighting towards large value US stocks DVY provides a wide exposure to numerous strong companies like Chevron, McDonald's, Clorox and Conoco Phillips. The ETF offers a forward-looking P/E ratio of 14.78 and respectable historical earnings of 6.02%.
Any investor looking for long-term wealth creation and easy exposure to strong dividend yields should closely consider DVY for their portfolio. When set to "dividend reinvest" the flywheel begins to gather speed building exponential value. This provides the added benefit of avoiding brokerage commissions and the ability to purchase fractional shares. Coupled with dollar cost averaging the process eliminates even more risk. Sometimes boring "stay the course" thinking provides excitement later.
Additional Disclosure: Catalyst Investments is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. This information is not investment advice or a recommendation or solicitation to buy or sell any securities. Catalyst Investments does not purport to tell or suggest which investment securities readers should buy or sell. Readers should conduct their own research and due diligence and obtain professional advice before making an investment decision. Catalyst Investments or anyone associated with Catalyst Investments will not be liable for any loss or damage caused by information obtained in our materials. Readers are solely responsible for their own investment decisions. Investing involves risk, including the loss of principal.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article was written by an analyst at Catalyst Investments.