High dividend stocks beat profits and government bonds

A study shows that from 1900 to 2005, dividends produced 90 per cent of the returns of investors worldwide. So focus as much on high dividend paying stocks as on earnings and government bonds.

In the long run, dividends will provide most of your returns, say London Business School academics Elroy Dimson, Paul Marsh and Mike Staunton. The authors examined the global returns of stocks in The Worldwide Equity Premium: A Smaller Puzzle.

From 1900 to 2005, the real (inflation-adjusted) return from stocks around the world averaged five per cent. But over this period, dividend yields averaged 4.5 per cent. This means that dividends accounted for 90 per cent of the return of the average investor in stocks. This suggests that investors should pay as much attention to cash dividends as they do to earnings—which managements sometimes fudge.

The managements of publicly-traded companies and stock analysts have a symbiotic relationship. That is, they take care of each other. A friend who works in the investor relations department of a large company explains how this works. He says, “I know what the reported earnings per share will be even before our accountants calculate them: they’ll equal what The Street [Bay Street analysts] expects.”

Management can massage earnings, but not high cash dividends

According to our friend, reporting earnings that are very different from what analysts predicted makes them look foolish. Clients may begin to doubt the judgment of these analysts. Companies that release positive or negative surprises (higher-than-expected or lower-than-expected earnings) could antagonize the analysts.

Rather than do this, the company will manage its earnings to come close to the consensus of the analysts. If earnings are significantly higher, the company might book some costs or defer booking some revenue. These actions will make the reported earnings come closer to the consensus. Conversely, if the earnings are much lower, the company could defer some costs and book additional revenue.

There are many other ways of presenting earnings other than reported earnings, of course. There are earnings excluding one-time items, operating earnings, pre-tax earnings and so on. We use adjusted earnings in those cases in which it will improve the comparability of a company’s results.

Focus on high dividend paying stocks

Cash dividends are much harder to fudge. After all, the company has to pay them out in cold, hard cash. That is, out of its holdings of cash and marketable securities or its cash flow.

Another distinct advantage of dividends is that they now yield more than bonds—for the first time since the 1950s. This is true in both Canada and the United States today. But it’s also true in overseas markets such as the United Kingdom, Germany and Switzerland. In fact, some investors in German and Swiss bonds have bought them for negative yields. Add inflation and these investors lost even more.

A second advantage with Canadian dividend stocks is that most of them qualify for the Canadian dividend tax credit—which reduces the tax department’s bite.

Many of The Investment Reporter’s Key stocks raise their dividends each year—or at least whenever they can during recessions. This gives you a growing stream of income. That, in turn, attracts income-seeking investors who bid up the price of your shares.

Focus as much on dividends (and cash and cash flow) as on reported earnings. And pick up more cash from dividends than from government bonds.

You needed stocks with high and rising dividends

A friend’s mother born in The Great Depression was often sent to buy groceries. With 25 cents she would buy a loaf of bread and a quart of milk and have six cents left over. As the Canadian dollar has lost much of its value, millionaires have become more plentiful—but being a millionaire is no longer what it once was.

We looked at figures from 1939 to 2004. Over this 65-year period, inflation averaged 4.1 per cent. This means that you would have had to have $13.624 million in 2004 to buy what you could have bought with $1 million when The Great Depression ended.

Just remember that wars and run-ups in the prices of critical commodities (such as oil) are inflationary. With few inflationary disruptions today, inflation may remain low for now—but it will eventually return. Top dividend paying stocks, especially those dividend aristocrats that raise their dividend every year, will help protect you from inflation.

 

The Investment Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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