Tony is over in Asia right now, trying to investigate as many new investment opportunities as he can. So he asked me to fill in for him this week.
Lately, you’ve been reading in Money and Markets about the sad state of affairs with regard to private and public pensions in the U.S., not to mention the gaping deficits facing the Social Security system.
Add to this the fact that Americans, as a whole, are saving less than just about any other society on the planet, and you can see how we may be facing a retirement crisis in the U.S. in the not-too-distant future.
Even if you’re in a much better position than millions of other Americans, you still face some key questions. Two of them:
How will you safeguard your wealth during the distribution or withdrawal phase?
How will you achieve an acceptable rate of return from your portfolio to stay comfortably ahead of inflation, without subjecting your nest egg to undue risks?
As an investment analyst at Weiss Capital Management, Inc., an SEC-registered investment adviser, I’m always looking for ways to help our clients answer these kinds of financial questions.
Today, I’d like to tell you about one possible solution — a common-sense, yet often overlooked, approach to investing …
Dividends: The Secret to
Outsized Total Return
Nilus Mattive has been writing in Money and Markets about a compelling investment strategy that’s focused on investing in financially strong, blue-chip stocks that pay attractive dividends.
Professor Jeremy Siegel, of the Wharton School at the University of Pennsylvania, has also been singing the praises of dividends. Recently, Siegel asked a crucial question: What types of stocks have built up the greatest wealth for investors over the years, and why?
At first blush, many investors would probably answer, “That’s easy — fast-growing companies like Microsoft have been the surest path to stock market riches — just ask Bill Gates!â€
However, that seemingly common-sense answer is wrong! In his new book, The Future for Investors, Siegel makes a persuasive case for investing in companies that sell “tried and true products.†He calls these companies “corporate El Dorados†because they earn steady profits and pay consistently growing dividends even if they operate in slow-growth industries. 1
In fact, according to Siegel’s research, dividends are one of the biggest factors in superior long-term returns. He says, “Dividends are the way investors know that the earnings are real.†2
Siegel also makes another important point: “Dividends not only protect investors in bear markets but have boosted returns significantly when the market rebounds.†3 With the S&P 500 index still in the process of rebounding from the bear market of 2000 to 2002, that could be very timely investment advice.
As you probably know, there are two separate and distinct components to a stock’s total return:
First, there’s the capital appreciation component of total return. This is the pure price appreciation of the stock by itself (of course, the price of a stock can also go down, which would negatively impact its total return).
Second, there’s the income component of total return, which is provided by any cash dividends paid over the time an investor owns the stock.
Many investors only think of capital appreciation when it comes to stocks. But since 1926, dividends have accounted for 35% of stocks’ total return, according to data from Bernstein Research. 4
Moreover, research from Ibbotson Associates indicates that, for large-cap stocks, the share of total return that comes from dividend income is even larger — accounting for 41% of total return. 5
In his research, Siegel noted an even greater advantage favoring dividend-paying companies. He found that from 1871 to 2003, fully 97% of the total return from stocks — after adjusting for inflation — came from the compounding of dividends, while just 3% came from capital gains alone. 6
My own research confirms the power of dividends. Here’s a case study that I did — it really brings these abstract concepts to life …
Johnson & Johnson And
The Power of Compounding
You’re probably familiar with the concept of compounding interest — the idea that as your money grows over time, you begin receiving interest on money already earned.
What many investors don’t know is that the remarkable wealth-building potential of compounding isn’t just a feature of pass-book savings accounts and other fixed-income investment vehicles. Dividend-paying stocks can also put the power of compounding to work for your portfolio.
Let’s take a look at Johnson & Johnson (NYSE: JNJ) as an example. This household name — maker of the ubiquitous Band-Aid, prescription medications and surgical products — is generally considered a boring, mature company.
I can see why — Since the S&P 500 made its bear-market bottom back in October 2002, JNJ gained about 20% on a price-appreciation basis. That translates into an annualized price advance of just 4% a year!
But remember, price appreciation alone is just part of the story — JNJ has also been paying out dividends through thick and thin, in both bull and bear markets.
To show you how important these dividend payments are, let’s examine a hypothetical investor who purchased 1,000 shares of JNJ’s stock back on the last trading day of 1989. The stock was priced at $59 3/8 per share and paid an annual dividend of $1.31 per share in 1990.
Based on those numbers, the stock’s dividend yield was just above 2%. That certainly doesn’t sound very enticing when you realize that a six-month U.S. Treasury note yielded 7.88% at the time. Still, you need to consider the growth in JNJ’s dividends and the effects of reinvesting those payments over the next 15 years.
JNJ steadily increased its dividend 14% annually from 1990 through 1999. And Johnson & Johnson’s dividend has been growing even faster lately — close to 16% annually over the past five years.
Result: By the end of 2004 — 15 years later — JNJ was paying an indicated annual dividend of $1.14 per share for a yield of 1.8%.
Wait just a minute, you’re probably saying, JNJ’s dividend yield actually declined over the 15-year period … and that yield is less than I’d get from a Certificate of Deposit!
That’s an illusion. For someone who bought JNJ in 2004, the yield is just 1.8% … but for the investor who purchased the shares back in 1990, it’s a very different story! Let’s do the math:
Over our selected time frame, JNJ’s stock split 2-for-1 on three separate occasions. So, our hypothetical investor purchased shares at a split-adjusted price of $7.42. Thus, by the end of 2004, our hypothetical investor was getting an effective dividend yield of 15.36% on the original amount invested ($1.14 divided by $7.42).
Try finding a CD yielding 15% — it wasn’t possible in 1990 and it’s certainly not possible today!
Plus, over the 15-year holding period, our hypothetical investor collected $59,130 in total cash dividends. Reinvesting those payments would have purchased another 2,326 shares for a total capital gain of $447,985.
Last but not least, there’s the stock’s capital appreciation. Over the 15-year period, JNJ’s stock climbed about 750% in terms of simple price appreciation.
Add in the power of compounding all those reinvested dividends and you’re talking about a 33% boost in your total return.
That’s an annual total return of roughly 17.3% per year over the entire period, and more than ten times your money from a boring old blue-chip stock that was considered mature back in 1990! 7
Here’s the bottom line …
Be Selective When it Comes
To Your Equity Investments
With stocks, you don’t have to hit the ball out of the park every time. Instead, your equity investments should be well diversified. And for the core of any stock-oriented investment strategy, it pays to consider dividend-paying blue-chip shares.
This is especially true for retired or soon-to-be-retired investors with 15, 20, or 30 more years of investing ahead of them. While not every stock is going to match Johnson & Johnson’s success, dividend-payers provide a measure of current income and still offer the long-term benefits of growth in both share price and dividend payments over time.
As a result, a dividend-paying stock’s yield has the potential to grow much larger over time as opposed to the static, unchanging yield offered by most other fixed-income investments.
At Weiss Capital Management, we believe prudent long-term investors, with a moderate tolerance for risk, should consider a dividend-stock investment strategy as an integral part of their overall portfolio. And that’s why we just finished up a free special report on these investments.
It’s also why we offer our clients the Weiss Select Equity Portfolio, a professionally managed investment strategy. This investment program aims for a combination of capital appreciation and income by investing in a diversified selection of high-quality, primarily dividend-paying stocks.
If you’re interested in learning more about the power of dividend compounding, you can order your free copy of our just-published report, Dividends Pay Off: A Tried and True Strategy for the 21st Century Investor, by clicking here. You’ll also receive an information kit for the Weiss Select Equity Portfolio.
If you’d rather order your free report over the phone, simply contact a Weiss Capital Management Financial Adviser at 800.814.3045 and mention offer code MAM1128.
Best wishes,
Mike
1 Jeremy J. Siegel, The Future For Investors, Chapter 3, page 48
2 Jeremy J. Siegel, The Future For Investors, Chapter 9, page 136
3 Jeremy J. Siegel, The Future For Investors, Chapter 10, page 154
4 The Bernstein Journal: Perspectives on Investing & Wealth Management, Autumn 2004
5 Al Frank Asset Management, The Value of Dividends, August 2005; source: Ibbotson Associates using data from Center for Research in Security Prices, University of Chicago
6 Jeremy J. Siegel, The Future For Investors, Chapter 9, page 126
7 All financial market data on Johnson & Johnson over the period discussed provided by Bloomberg Market Data. Johnson & Johnson common stock may or may not be held as an investment in Weiss Capital Management client portfolios at this time. This stock is shown for illustrative purposes only and IS NOT intended to represent individual, specific advice to buy or sell this security.
Important Disclaimer:
The opinions contained herein are those of Michael Burnick, investment research analyst at Weiss Capital Management, and Weiss Capital Management. They are subject to change without notice, are not intended to be a forecast of future events, or a guarantee of future results or investment advice.
Please click here for Important Disclaimers and Disclosures.
About MONEY AND MARKETS
MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Amber Dakar, Wendy Montes de Oca, Kristen Adams, Jennifer Moran, Red Morgan, and Julie Trudeau.
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