When you’re researching stocks to add to your portfolio, how much do you focus on dividends?
If it’s not a focal point, then you could be shortchanging your investment returns. That’s because studies have shown that continuously increasing dividends are the hallmark of an excellent business — and excellent businesses usually translate into excellent investments.
Below, we share a classic essay from our CEO, Brian Hunt. It looks back over nearly 40 years of market performance data to reveal a critical truth about what’s behind big returns.
This study, and Brian’s essay, contains some of the most valuable investing data you’ll ever see.
The Secret of High Stock Market Returns
Looking back at nearly 40 years of performance data, there’s a clear pattern of which stocks can deliver big returns
By Brian Hunt, InvestorPlace CEO
When a great business develops a durable advantage over its competitors, it often begins paying steady and rising dividends.
Dividends are cash payments distributed to a company’s shareholders. They are often quoted in dollars per share, as in “Coca-Cola (NYSE:KO) pays a dividend of $1 per share.”
Dividends are also quoted in terms of a percent of the current stock price. This percentage is referred to as the “yield.” You might say, “Coca-Cola pays a dividend yield of 3%.”
The respected investment research firm Ned Davis Research produced a study that shows why investors should care a lot about dividends.
This study contained some of the most valuable data you’ll ever see.
Understanding this data can make you rich. Not understanding it can cost you years of wasted effort and lots of money. I’ll show you this data in a simple table.
You shouldn’t invest one dime in the stock market unless you understand it.
In the study, Ned Davis Research analyzed the returns of various types of stocks within the benchmark S&P 500 index from 1972 to 2016.
Ned Davis Research placed each S&P 500 stock into one of four general categories:
1. They placed companies that were reducing or eliminating their dividend payments into one category.
2. In another category, they placed companies that didn’t pay dividends.
3. In another category, they placed companies that were paying dividends, but not increasing them.
4. In another category, they placed companies that were paying dividends and were increasing them.
In other words, Ned Davis Research categorized stocks based on their policies of paying cash to shareholders.
You could say two of the categories (reducing dividends or not paying dividends) consisted of businesses that were generally not good at paying cash to shareholders.
You could say one category consisted of companies that were okay at paying cash to shareholders (paying dividends, but not increasing them).
You could say the fourth category consisted of stocks that were great at paying ever-increasing amounts of cash to shareholders (paying dividends and raising them).
According to the study, companies that paid growing dividends returned an average of 9.86% per year. Companies that were paying dividends but not increasing them returned an average of 7.33% per year. Companies that did not pay dividends returned an average of 2.46% per year. Companies that were cutting or eliminating their dividends returned -0.47% per year.
Here is that data shown in a table:
The results of the over 40-year study are clear: Companies that are great at paying cash to shareholders perform better than companies that stink at it. As the ability to pay dividends increases, returns go up. As the ability to pay dividends declines, returns go down.
Continuously rising dividends are a mark of business excellence. And business excellence translates into big shareholder returns.
“Wait a minute,” you might say. “If I only buy stocks that don’t pay dividends, won’t I miss out on big growth stock winners that invest their profits into growing the business instead of paying it to shareholders?”
To this objection, I say, “Yes, you will.”
By sticking with dividend-paying stocks, you will miss out on investing in the next Starbucks (NASDAQ:SBUX) … or the next Facebook (NASDAQ:FB). But remember, for every winner like Starbucks, there are 1,000 failed coffee chains.
For every winner like Facebook, there are 1,000 failed websites.
It’s very, very unlikely that the average investor will be able to consistently find these companies early on … and hold them for years. Even trained professionals struggle (and often fail) to pick those kinds of winners.
It’s much, much more likely the average investor will be able to consistently identify companies that sell boring, basic products like soap, burgers and beer … and pay ever-increasing dividends.
By now, you know those companies are usually found in your refrigerator, cupboard or medicine cabinet.
If you’re interested in building long-term wealth in the stock market, consider changing the way you look at different stocks.
Consider placing each business you come across into one of four simple categories.
And only buy businesses that fit into one of those categories: the rising dividend category.
Does the business pay rising dividends, stagnant dividends, no dividends, or is it reducing dividends?
If the business doesn’t pay continuously rising dividends, pass on it. Here’s a simple rule of thumb for you to follow.
Buy the best and ignore the rest!