Thursday, September 7, 2017

The dumbest argument against dividend paying stocks

One of the dumbest arguments against dividend growth investing is showing a single investment that failed, and thus implying that the strategy is not good. An opponent of dividend growth investing would usually use a company like Eastman Kodak (KODK), General Motors (GM), or one of the major banks like Citigroup (C) as an example of type of stocks that investors believed to be buy and hold forever.

There are several logical flaws with this argument.

The first issue stems from the fact that only some of the banks used in this argument have ever been dividend growth stocks at the time of their demise. General Motors, which was one of the bluest of blue chips for decades, had never been a dividend growth stocks, because of the cyclical nature of its distributions. Eastman Kodak was a dividend achiever once, having raised dividends for 14 years in a row through 1975, when the Board of Directors elected to freeze distributions. This was over 37 years before the company declared bankruptcy. Since 1975, the company had raised dividends off and on, but never for more than five consecutive years in a row. After the company cut dividends in 2003 however, no objective dividend investor should have held on to the stock.

Most dividend growth funds, such as the Dividend Aristocrats and Dividend Achiever ones, as well as many dividend growth investors would dispose of a security after it cuts or eliminates dividends. I do so too, per my risk management guidelines.

The second issue with the argument is that it misses the fact that only a portion of investments will be winners.  The thing about every single investment strategy out there is that only a portion of the investments you make will be winners. Even Warren Buffett has not made money on every single investment he has made. The man is happy if he can find a 40% hitter, and stick to them. A rational investor cannot expect to win on every investment he or she makes. However, if they maximize their gains by sticking to their stock holdings that are successful, they would more than make up for the losers over time.

The person making the isolated example of failure, merely uses this "argument" as a means to weaken Dividend Growth Investing by focusing on isolated "failures", while forgettting about the big picture. That's in an effort to make the strategy they are selling look better. This is why dividend growth investing failures are always exaggerated, while dividend growth successes are simply ignored. But in reality, this is sloppy thinking, which shows the person arguing misses the forest for the trees.

The third issue with this argument is that it ignores how General Motors, Eastman Kodak and the banks such as Citigroup were actually part of the S&P 500 or Dow Jones Industrial's Averages at the times of their dividend suspension or cuts. These companies were once regarded as the bluest of blue chips, and were members of all other major proxies for US stocks. If these are examples that should prevent investors from following a certain strategy, it looks like since these companies failed, the argument should be that investors should not buy stocks or should not buy index funds altogether. It means you should never invest in equities ever again. If investors are afraid that one or several of the companies in their portfolio will fail at some point in the future, they should never invest in index funds, or follow any stock investment strategy. Now that I have stretched the original argument, hope you can see its ridiculousness.

The fourth issue with the argument is that it ignores the fact that dividend investors hold diversified income portfolios, consisting of over 30 individual securities. If a few companies that the dividend investor has identified fail, that would surely hurt. However, the portfolio base would not be in dire straits, as the rest of the components would pull in their weight and raise dividend income over time to eventually reach record territory once again.

Even index funds may not be a magic panacea for poor investor performance. If the investor panics during bear markets, takes excessive leverage, or decides to wait in cash for months or years until the prices get cheaper, they might not make much money. Of course, index funds change approximately 5% of components each year. Those indexes look like daytraders when compared to dividend growth investors, who rarely sell, and hold through thick or thin.

The fifth issue is that dividend paying companies pay dividends and may spin-off companies to shareholders as well. As I have discussed before, dividends represent a return on investment, as well as a return of investment

For example, General Electric stock in 2020 is back to where it was at the end of 1992.

Yet, if you had bought 1 share of the stock for $6.86 at the end of 1992, you would have collected $17.80/share in total dividend income through 2020. The amount received in dividends is over two and a half times the amount of the original investment. If you reinvested those General Electric dividends, you end up with 7.69 shares of General Electric which is not bad.

Now imagine if you reinvested each quarterly dividend in a different company or a portfolio of companies. That money could have been invested elsewhere, and generate a respectable rate of return.

Other times, companies may spin-off subsidiaries. Eastman Kodak is one such example. The company went bankrupt in 2012, wiping out its shareholders.

If you invested $1000 in Eastman Kodak in 1957, kept spin-offs and invested dividends you would have $64,000 today.

Your positive returns are entirely due to the 1994 spin-off of Eastman Chemicals (EMN)

Few investors seem to think about investments like a business owner. And it shows.

The last issue with the argument is that it never provides alternatives to dividend investing. As a dividend investor I have spent thousands of hours researching and fine-tuning my investment strategy, and by digging through the information about the companies I am interested in. I have chosen to follow a strategy because it fits my goals and objectives. I typically ignore naysayers who tell me my strategy is bad, without providing me any clear alternatives to that.

In my dividend investing I expect that roughly 20% or so of companies I invest in will generate the majority of dividend and capital gain profits. The remaining will either break even or produce net investing losses. If the companies in the winning group go up tenfold in value with dividends reinvested over the next 20 years, with 40% doubling on average, while the companies in the losing group lose 50% of their value, I would expect that I would end up with a portfolio that could triple in value over a 13 - 14 year time period.

You are not going to come up ahead on all investments you make in your lifetime. But if on aggregate the ones you own end up throwing up more in income over time, you should do quite well for yourself.

In order to find quality dividend stocks for my portfolio, I start with the list of dividend champions, take them through my screening criteria, and then analyze each candidate one at a time. I then do the same exercise using dividend contenders/dividend achievers lists and try to make investments every month in those that offer the best values at the moment.

Full Disclosure: None

Relevant Articles:

Dividend Investing Over the Past Seven Years Was Never Easy
Dividends Make Investing Easier During Market Declines
Key Ingredients for Successful Dividend Investing
Is international exposure overrated?
Frequently Asked Questions (FAQ) About Dividend Investing

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