YOU OFTEN SPEAK PRETTY PASSIONATELY ABOUT COMPANIES THAT PAY DIVIDENDS, WHY IS THAT IMPORTANT?
Andrew, you often speak pretty passionately about companies that pay dividends in my investment portfolio. Why is that important? Do you pick the companies and do I sacrifice better returns from other types of companies?
This month's book from our must-read financial library goes to Ron for his question about dividends. His question address some fundamental investment concepts often misunderstood by investors or not even considered. Below I will begin to share my perspective on Dividend Growth companies.
Ron’s Question, Andrew, you often speak pretty passionately about companies that pay dividends in my investment portfolio. Why is that important? Do you pick the companies and do I sacrifice better returns from other types of companies?
The answer to that question is multi-layered and a wonderful investment story about owning the great companies of this country and the world and getting paid while we do. First, we need to be crystal clear that the portfolios we construct for our clients are designed for each individual, couple, or family. Portfolio construction is informed by their financial plan and therefore their individual goals and investment philosophy. Second, we allocate among many asset classes, not just dividends. However, dividends are core to most of our client’s portfolios. Third, we include not just any dividend, but dividends paid by companies with a high probability of continuing that payment. For example, ATT has paid a dividend consecutively since 1893. Equally important, we invest in companies that have a high probability of increasing their dividend year over year. Pepsi has increased its dividend for more than 50 years consecutively.
I absolutely do not pick the individual stocks in a portfolio.I am a financial advisor, not a portfolio manager. Those are two distinctly different jobs. It is my job to work with clients to design and execute a plan to accomplish their financial, retirement, income, and legacy goals. In that role, we seek to find those money managers who have demonstrated they do something special. We then bring them to bear on our portfolio construction. ( more on active vs. passive management another day.)
By the way, I believe the selection of the companies in a growth dividend portfolio should not be indexed, but require expert selection and active management. Not all dividend paying companies are equal.
As I said, companies that pay their shareholders a stream of growing dividends are important for people who need income from their portfolios. (There is more to the story for investors who desire income than just cash back.) But what about investors whose goal is long-term growth, are they sacrificing return investing in dividend payers?
Consider the following. Dividends are a percent of a company’s free cash flow. That is a portion of a company's profits after all the bills and taxes have been paid. Dividends are paid on a per-share basis, you own a share you get a dividend, regardless of share price fluctuation. If investor then takes that cash and uses it to buy more shares of the company (automatic reinvesting) they can create a higher and higher cash payout in the future. More shares paying more cash buying more shares, so on and so on, the miracle of compounding! Wait there is more; if that same company over time, sometimes year over year, increases the cash dividend paid per share there is a kind of double compound. More and more shares paying a higher and higher dividend. Add to this compounding the fact that as share prices fluctuate and we reinvest our dividends we are employing dollar-cost averaging, a tried and true long-term investment strategy, as you can see, the effect for long-term investors can be quite dramatic.
Albert Einstein is reputed to have said, “compound interest is the eighth wonder of the world. Who am I to question Albert Einstein?
The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts or Lincoln Investment. The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. There is no guarantee that any strategies discussed will result in a positive outcome. You should discuss any legal, tax or financial matters with the appropriate professional. All investing involves risk and no investment strategy can guarantee a profit or protect against loss, including the potential loss of principal. A plan of regular investing does not assure a profit or protect against loss in a declining market. You should consider your financial ability to continue your purchases over an extended period of time.