A Summer Stroll #2 -- The Story Begins

Note: To best understand this blog, please start at A Summer Stroll -- Part 1 The story of dividend investing is really a story within a story: the first is the series of events that led to my becoming a dividend investor and the second is what I have learned along the way. There has been much written about dividends in the past few years, including many academic studies, that show, conclusively, that dividends matter. I will cite a couple important studies later, but first let me share some of my own findings. I mainly use the Dow Jones 30 for my analysis because I have found that using this smaller group of companies, rather than the 500 in the S&P, has given me additional insight into what was driving my findings. Most academic and Wall Street research is done on the S&P 500. Please note when I change back and forth between the two. The data are very similar, but they do differ at times. In the 44 years from 1960 throughout the end of 2004, the total return of the Dow Jones 30 Industrials has averaged 10.4% annually, consisting of 6.7% price growth and 3.7% in dividend return. This means that nearly 36% of the total return of this important index has come from dividends. Many of you have read this statistic before, but you still see dividends as a bonus, rather than the powerful indicator of the true investment value that they are. Dividends have two qualities that put them in a class by themselves as far as offering a reliable long-term gauge of rate of return: they are real money( and it's real money we are after, not paper profits) and their growth trend is much more stable than earnings or sales, the most commonly followed corporate financial data. To start to visualize the power of the dividend as an indicator of total return, first consider that since 1960, dividend returns have ranged between 1.6% and 6.1%, a difference of only 4.5%, while price returns have ranged from -17.8% to 35.1%, a difference of 52.9%. At first these data do not appear to help us because, even though dividends have represented over a third of total return and are very stable, it is nearly impossible to estimate the future price return of the markets or a stock because prices are so volatile. The volatility of prices would seem to destroy any hope we have of estimating future total returns, and I will add, it is this volatility that damages investors' ability to stay the course in their investment strategies. Time and again, I see investors cut and run in periods of high volatility, and my heart sinks when they do. In my judgment there is no other passive investment on earth that rivals the wealth producing capacity of the stock markets, but this wealth-producing capacity comes with a price -- volatility. To find a way to see through volatility, as you will see later, became my quest during the crash of 1987. I will describe that story in a later edition of our walk. But here is where the second important quality of the dividend comes to the rescue -- its much lower volatility. Long-term dividend growth has been similar to long-term price growth, 5.4% to 6.7%. If we could prove that there is some correlation between long-term dividend growth and long-term price growth, we could use dividend growth as a less volatile proxy for price growth, and we would then have an instrument to cut throughout the fog of the day to day high volatility of stock prices and determine a "true" expected expected return from the markets or an individual stock. This is the search that I have been on for over 20 years. For my money, I have found the relationship that connects the two, and in doing so, as many of you know, I don't pay much attention to the day to day machinations of the stock market, however, come dividend time I am like a lion on the prowl. In the weeks ahead, I will share with you what I discovered that connects dividend growth with price growth and how we use it. I will also, hopefully, acquaint you with the term dividend total return, or dividend return as the primary was of valuing a security. Talk to you soon.