Tuesday, March 12, 2013

S&P 8000 – The power of reinvested dividends in action

The S&P 500 index was introduced by Standard & Poor’s in 1957 in its current format. This index is used by mutual funds, hedge funds and individual investors are a benchmark against which they compare their performance. I also use the S&P 500 dividends as my benchmark for dividend income. I essentially compare the growth in distributions that I receive in my portfolio to the growth in distributions in the S&P500.

One of drawbacks of stock market indexes in general is that they only show price returns. While capital appreciation has delivered approximately 60% of average annual returns, this is just a portion of total returns. If you ignore the 40% of the annual source of returns, you end up with a benchmark which does not reflect the actual performance of investors’ portfolios.

If you add in reinvested dividends, one would notice that equities did provide some nominal returns over the so called lost decade in the early 2000’s. For example, using reinvested dividends, S&P 500 managed to conquer previous all-time highs set in 2000 by 2006. The S&P 500 prices managed to exceed the previous highs in 2007.

In addition, if you add in reinvested dividends, investors who purchased right at the top in 2007 managed to break-even by 2012. The S&P 500 is still a few percentage points below its all-time highs set before the financial meltdowns.

I found historical data for S&P 500 going back to 1950 from Yahoo! Finance. I also found historical dividend data from Standard & Poor’s and Prof Schiller’s website. I calculated the level of S&P 500 index starting on December 31, 1956 if distributions had been reinvested. I used 12/31/1956 as the starting date because the index was first presented in its current form in 1957.

If you look at the data, it is evident that the index is close to 8,000 points. This is over 5 times the amount of S&P 500 index today. Over time, the divergence between these two values will continue to widen, particularly as more companies included in the index adopt dividend friendly policies.

The following stocks not only provided investors with stable price returns during the financial crisis, but also managed to increase distributions like clockwork every year. This was no surprise for long-term shareholders however, which had been used to regular dividend increases during the previous 2 – 3 decades. In addition, these companies have each exceeded their 2007 highs:

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The company has been able to generate earnings growth in order to achieve a 39 year streak of dividend increases. While the stock was grossly overvalued in 2000, by the late 2000's it became attractively valued again. When an attractively valued stock manages to grow earnings and raise dividends, it tends to attract enterprising dividend investors. Currently, Wal-Mart is trading at 14.50 times earnings and yields 2.60%. Check my analysis of Wal-Mart.

McDonald’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. This dividend champion has managed to raise dividends for 36 years in a row. The company has continued to innovate in its menu, and its operational excellence has made it a well-known global brand. McDonald's has managed to grow revenues and earnings even during the recession, The stock had been attractively valued for most of the past six years. Currently it is changing hands at 18.40 times earnings and yields 3.20%. Check my analysis of McDonald's.

Full Disclosure: Long WMT, MCD and an S&P 500 index fund

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Benchmarking Dividend income
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Dividend Champions Index – Five Year Total Returns Performance
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