At our firm, we believe in the concept of TDR, the acronym for Total Dividend Return. TDR is important to us because we believe it can offer a rough approximation of the total return (TR) of a stock over the long-term. We define Total Dividend Return as dividend yield + dividend growth. Total Return, on the other hand, is defined as dividend yield + capital appreciation. Total Return is the standard way of measuring rate of return, but it implies that today’s price is the only measure of a company’s value. We believe that is shortsighted, especially in volatile times like today's market.
Please note in the definitions above that "dividend yield" is contained in both. It should be because dividends are real money and have represented almost 40% of the total return of stocks over the long-term. Yet, just because dividends have been nearly 40% of the return for stocks over the long-term, what is our rationale for thinking that they can also explain the other 60% of total return?
Oddly, our research shows that for most companies, TDR doesn't work. For the average stock there is not enough of a correlation between price growth and dividend growth, thus TDR is of no help in determining value. However, for about 25% of the companies in the S&P 500 and about 15% of the major companies of Europe, there is a strong relationship. In some cases, the correlation is near 90%. For this short list of companies, an old adage we like to use is: So goes the dividend, so goes the stock.
Where a correlation exists between a company's price and its dividend, TDR is an important tool in uncovering value. The reason is simple: dividends for most companies are far less volatile than earnings, sales, or any other financial data. If a company's dividends are easier to predict than these other variables, then by extension over the long run, so are their prices.
Total Dividend Return then becomes our compass. It is our means of understanding where we are in the market’s vast universe of stocks, and which direction to go to find the best and most predictable values.
The table below shows a few companies whose dividends have been highly correlated to their prices over the last 20 years.
I chose these companies because they represent a wide range of industries and have long histories of paying and increasing dividends.
As the table shows, the average price growth of among these companies has been about 13% over the last 20 years. Remarkably, dividend growth has averaged only slightly less at 12%. A look at some of the individual members of the list is even more remarkable. The respective price and dividend growth data for Wells Fargo, GE, and Pepsico are almost identical over this 20-year period.
Now think about this for a moment. Are the boards of directors of these companies raising their annual dividends to match the annual price growth of their stock? Or is it the other way around; Is the price growth of the stock getting its cues from the board's dividend increases? We believe it to be the latter.
Next time we will compute the projected Total Dividend Return over the next three to five years for the aforementioned companies, using their current data.