If the current volatility on Wall Street was not worrisome enough, there could be a degree of vulnerability to corporate dividends. The reality is that dividends are paid at a company’s discretion. There is no legal obligation on the part of a company to pay, or much less increase, their dividend.
To conserve cash in the ongoing coronavirus environment, companies such as Ford and General Motors have already eliminated dividends.
“In a recession, companies curl up into a fetal position and they cut employment, production and inventories,” said Edward Yardeni, an independent market researcher. “They stop buying back their own stock, and then, if they are still bleeding cash, they cut dividends.”
This could become a problem for investors. For example, the economist Richard Thaler, a Nobel laureate, found that people often use simple rules, or heuristics, to guide their behavior. Specifically, you have probably heard the often-touted mantra of never touch principal – live off dividends and interest.
A report published in 2013 by J.P. Morgan Asset Management examined the returns of various groupings of stocks over a 40-year period (1972-2012). Companies that initiated and grew their dividend over this four-decade stretch returned an average of 9.5% per year.
By comparison, non-dividend-paying stocks averaged returns of only 1.6% per year over this same period. That is an improvement of about 500% in favor of dividend paying stocks.
A similar statistic probably holds true today. Why, you ask? A key reason is that corporations with a dividend track record are generally profitable and have successful time-tested business models. In other words, dividends are perfect beacons of profitability that entice long-term investors.
There is more. Companies that continually pay a regular dividend, and maybe even increase it regularly, go a long way to assuaging investor concerns when Wall Street turns south, as it has done periodically over the past several weeks.
Although the yield earned of dividend stocks is likely to be far less than the loss received during a correction, it certainly helps lessen the agony.
Moreover, the discomfort will be further minimized if you keep your analysis to companies that have a track record of raising dividends for 10-years or more. In other words, continually since the start of the Great Recession.
A good example is Warren Buffett. As CEO of Berkshire Hathaway, Buffett has personally selected most of the stocks in the company’s $200 billion-plus portfolio.
Of the 48 companies currently selected, 32 pay dividends. Buffett loves investing in top-quality dividend paying companies. As a result, the portfolio generates billions in dividend income for Berkshire’s operations.
Coca-Cola has been a staple of Berkshire’s portfolio for decades and has increased its dividend for 57 consecutive years. Yes, I must admit I am a greater fan of Pepsi, which has a track record of 48 years of increased dividends.
Apple, another of Buffett’s favorites, is a relatively new dividend payer, but already has a strong history of dividend increases.
Buffett’s faith in dividend stocks is simple, they generate a consistent source of cash flow that Berkshire Hathaway can deploy elsewhere.
Similar characteristics apply to the rest of Berkshire’s dividend paying portfolio – not overly capital-intensive, are “forever” industries, and/or have a robust competitive advantage.
Given the importance of dividends in not only providing income but also in aiding an investment’s overall performance, it may benefit you to see if your portfolio could use some exposure to companies that provide this source of cash flow.
You can write to Lauren Rudd at Lauren.Rudd@RaymondJames.com or call him at 941-706-3449. For back columns go to RuddInternational.com.