Rising dividends still beat government bonds

A study shows that from 1900 to 2017, dividends produced 90 per cent of the returns of investors worldwide. So focus as much on dividends as on profits and government bonds.

Rising_DividendsIn 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 2017, 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.

What you expect is what you get

The managements of publicly-traded companies and stock analysts often 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 the accountants calculate them: they’ll equal what ‘The Street’ [Bay Street analysts] expects.”

According to our friend, reporting earnings that are very different from what analysts predicted makes them look foolish. Employers and 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 profits other than reported earnings, of course. There are earnings excluding one-time items, operating earnings, core 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.

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 advantage of dividends is that high and rising dividends now yield more than government bonds. This is true in both Canada and the US. But it’s also true of developed overseas markets, such as Japan, Britain and most of Continental Europe. In order to stimulate their economies and keep their financial systems sustainable, many central banks cut interest rates sharply in recent years. According to The Economist, “Even if dividends did turn out to be stagnant for the next decade, investors would still get a higher income from equities than from government bonds.” At least until interest rates recover.

Many of our 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.

A million isn’t what it once was

A friend’s mother born in the Great Depression would buy groceries. With 25 cents she would buy a loaf of bread, a quart of milk and have six cents left over. As the loonie has lost much of its value, millionaires—even excluding real estate—have become 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 to have C$13.624 million at the start of 2005 to buy what you could have bought with $1 million when the Great Depression ended.

Just remember that printing paper—or synthetic polymer—money, wars and run-ups in the prices of critical commodities are inflationary. With few inflationary disruptions today, inflation may remain low for now—but it will eventually return.

This is an edited version of an article that was originally published for subscribers in the April 13, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

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