What Percent Of Your Return Is From Dividends?

Jul. 28, 2015 9:54 AM ETAAPL, CSCO, GE, INTC, MCD, NKE, UNH, WMT, AXP, CVX, GS, JNJ, MMM, PFE, UTX, XOM, BA, DD, HD, JPM, MRK, PG, V, CAT, DIS, IBM, KO, MSFT, TRV, VZ44 Comments
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Eli Inkrot
8.52K Followers

Summary

  • In a previous article I broke down the return of the Dow constituents into five important components.
  • From that commentary came the observation that total returns are largely driven by capital appreciation.
  • While this was mostly true in a decade illustration, the degree to which might be a bit surprising.

In a recent article I broke down the returns of the Dow constituents into five important components: revenue, profit, EPS and share price growth to go along with dividends paid. An astute reader had a good question about the relative importance of each, and provided an assertion that it appeared the vast majority of the returns were generated by price appreciation.

Let's walk through why this is a reasonable observation, along with perhaps a more helpful way of looking at the process.

I'll later provide information on all 30 current Dow components, but for now let's walk through just a single example. If you were to look at Verizon (VZ) over the 2005 through 2014 period you would see that the share price increased by about 5% per year, while the security as a whole provided 8.7% annualized total returns including dividends. From this observation it appears that the total return generated was due more as a result of the share price as compare to the dividends received.

Yet this wasn't the case. At the end of 2005 shares of Verizon were trading hands at $30.12. By the end of 2014 the share price had increased to $46.78 - $16.66 higher than what it was. On the dividend front, you would have collected $17.07 in payments along the way. In just looking at the share price and total returns this isn't intuitively obvious. It's just the way compounding math works.

I'll work through each component to make this point clear. If you begin with a $30.12 share price and move to a $46.78 price over nine years, this represents a 55% overall gain or roughly 5% per annum. Then if you add in $17.07 in dividend payments you come to a total value of $63.45. This represents a total gain of 112% or 8.7% on an annualized basis. It's not a linear process. Once you start compounding, it changes the dynamics of the equation.

Alternatively, you could look at dividends first. You start with a $30.12 share price and collect $17.07 in dividend payments for a total value of $47.19. This represents a 57% overall gain or 5.1% on an annualized basis. Then you add in the $16.66 in capital appreciation to reach the same $63.85 total value. Either way, necessarily, the total annualized return will be the same. Yet it's paramount to note that you can't simply add the compound rates of either component.

Once you start compounding it becomes more instructive to think about the amount of the return and not the annualized rate of each component. In this particular case, Verizon had a total return of $33.73 over the period - $17.07 was from dividends and $16.66 was from capital appreciation. In other words, 51% of the return was generated from dividends and the remaining 49% from capital appreciation. This is something that's not intuitively obvious by simply looking at the share price appreciation and total annualized return.

Likewise, this same type of analysis carries through to any other company. Incidentally, this is also a reason that many people overlook the power of dividends. When you see capital appreciation of say 5% or 6% to go along with total returns of 8% or 9%, you might suspect the share price move is much more important than the dividends received. Yet as illustrated above, this may not be the case.

Here's a look at the share price appreciation and total annualized return for each component over the past nine full years:

Company

Share Price

Total Return

3M (MMM)

8.7%

10.1%

American Express (AXP)

6.8%

7.6%

Apple (AAPL)

30.2%

30.7%

Boeing (BA)

7.1%

8.5%

Caterpillar (CAT)

5.2%

7.2%

Chevron (CVX)

7.9%

10.5%

Cisco (CSCO)

5.5%

6.3%

Coca-Cola (KO)

8.6%

10.7%

Disney (DIS)

16.4%

17.0%

DuPont (DD)

6.3%

8.5%

Exxon Mobil (XOM)

5.7%

7.7%

General Electric (GE)

-3.6%

-0.8%

Goldman Sachs (GS)

4.7%

5.6%

Home Depot (HD)

11.2%

12.3%

Intel (INTC)

4.2%

6.0%

IBM (IBM)

7.7%

9.3%

Johnson & Johnson (JNJ)

6.3%

8.3%

JPMorgan Chase (JPM)

5.2%

6.9%

McDonald's (MCD)

12.0%

14.5%

Merck (MRK)

6.7%

9.3%

Microsoft (MSFT)

6.6%

8.0%

Nike (NKE)

18.0%

18.7%

Pfizer (PFE)

3.3%

6.1%

Procter & Gamble (PG)

5.2%

7.1%

Travelers (TRV)

10.1%

11.5%

United Technologies (UTX)

8.3%

9.9%

UnitedHealth (UNH)

5.6%

6.1%

Verizon

5.0%

8.7%

Visa (V)

30.8%

31.2%

Wal-Mart (WMT)

7.0%

8.5%

From this view you might suppose that the share price made up the overwhelming majority of your returns. If you did a simple average you'd suspect that 85% of your return was generated from capital appreciation. Yet the picture changes a bit when you think about the amount of the return rather than just annualizing each component. Here's a look at the actual percent that each part of the return contributed:

Company

From Sh Price

From Divs

3M

81%

19%

American Express

86%

14%

Apple

96%

4%

Boeing

79%

21%

Caterpillar

67%

33%

Chevron

67%

33%

Cisco

86%

14%

Coca-Cola

73%

27%

Disney

94%

6%

DuPont

68%

32%

Exxon Mobil

68%

32%

General Electric

NA

NA

Goldman Sachs

82%

18%

Home Depot

87%

13%

Intel

65%

35%

IBM

77%

23%

Johnson & Johnson

70%

30%

JPMorgan Chase

70%

30%

McDonald's

75%

25%

Merck

64%

36%

Microsoft

78%

22%

Nike

94%

6%

Pfizer

48%

52%

Procter & Gamble

67%

33%

Travelers

82%

18%

United Technologies

79%

21%

UnitedHealth

90%

10%

Verizon

49%

51%

Visa

97%

3%

Wal-Mart

77%

23%

Note that capital appreciation is still very much favored - when you have a 2% yield and say 10% annual returns, you can't expect the dividend to make up the majority of this gain. However, it's not as lopsided as it might originally appear. This time a simple average would indicate that roughly 75% of the returns were generated from capital appreciation against the remaining 25% in the form of dividends.

Moreover, its important to note that dividend is always a positive component. (Long gone are the days of "negative dividends" or capital calls.) Although I zeroed out the values generated by General Electric due to a negative total return, in every single instance you would have received dividend payments from these companies. In two cases - Verizon and Pfizer - the dividend component would have made up over 50% of the total return. In 11 instances, the dividend accounted for roughly a third of the total return. Once you start reinvesting, the dividend becomes an even more important concept.

From this information we can glean two important concepts, which are naturally somewhat at odds with one another. The first thing to consider is that the dividend often makes up a sizable portion (or at least a portion) of your return. As such, whether you're a dividend gal or an all growth guy, it makes sense to pay attention to a company's dividend policy - it could make a difference with regard to future investing decisions.

The second observation is that while the dividend component might contribute a larger portion than you originally anticipate, it still does not make up the majority of the return. This will likely hold for some time, at least in the short and intermediate-term.

As such, there are a couple of concepts to keep in mind. Given that the dividend is likely to be a smaller component of your return, those aiming to live off this component exclusively have a bit of a "margin of safety" baked into their investment program. If you only take the dividend payments, it's likely that the share price will continue to grow through the years. Not absolutely, not every single year, but eventually in an aggregate portfolio the share price drifts higher and higher. Such is the nature of profitable businesses.

This extra margin can be useful. For one thing it allows you sleep better at night, knowing that there exists an additional return component (which might even be greater) that's compounding away as you focus on the dividend cash flow provided. For another, if you happen to hit a rough patch or else simply want to expand your cash flow, it makes you realize that you could sell some shares, collect all the dividends and still stand a reasonable shot at getting richer over time.

In short, when you look at a stock chart or annual returns you might suspect that dividends make up just a small fraction of the overall return. While it is true that the majority of your return could likely be derived from capital appreciation (especially in the short-term), there are quite a few footnotes to go along with this sentiment. As demonstrated with Verizon, the dividend might have a much larger effect than you had once imagined. Moreover, even if the dividend makes up just a fraction of the return, it can still be important and always positive.

This article was written by

Eli Inkrot profile picture
8.52K Followers
Eli Inkrot is a writer. Check out his website: thecurrencyoftime.wordpress.com, his articles here on Seeking Alpha or his book - "You Don't Have A Money Problem" - on Amazon.com. Additionally, here is a quick bio: Eli has held the title of Vice President and Portfolio Manager at EDMP Inc. - a money management firm - along with Vice President for F.A.S.T. Graphs - a financial software company. Prior to that, he began his investment career as an analyst in private real estate for a public pension fund. During his time in real estate he was the lead for a variety of accounts with net asset values totaling nearly two billion dollars. Eli received a Master’s in Finance from the University of Tampa where he earned “highest honors” whilst receiving the distinction of being named the “most outstanding graduate student.” He also holds an undergraduate degree in Economics and Business Administration from Otterbein University, graduating “magna cum laude” with distinct honors in each major. During his tenure at Otterbein, Eli was a member of the varsity golf team, held the departmental Senator position for Business, Economics and Accounting and studied abroad in the Netherlands.

Disclosure: I am/we are long GE, MCD, CVX, XOM, JNJ, PG, IBM, KO. 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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