I spend entirely too much time on Reddit…
For readers who aren’t familiar with Reddit, it’s a social media site that provides personalized news feeds determined by the sub-Reddits that each user tracks and follows. And scrolling through these feeds is a guilty pleasure of mine.
Funny enough, Reddit was founded by a couple of fellow University of Virginia grads a few years before I attended school.
To this day, there’s still a plaque commemorating the “Birthplace of Reddit” in my favorite library at the University.
The quality of the content on the site is hit-or-miss these days.
Some are insightful. Others are marginally helpful. Some have devolved into nonsensical echo chambers.
That’s the problem with social media. For every highly intelligent member of online communities there are dozens of people who… aren’t.
Case in point…
I read r/Dividends daily. It gives me a sense of the income investing ethos. And there’s one common misconception in this group that drives me crazy.
It’s a mistake that too many dividend investors make. And I don’t want you to be one of them.
Dividends Are Meaningless?
A lot of investors believe that dividends are “meaningless.”
They think that nothing in the market is free, and a dividend is simply a taxable event that transfers wealth from a company to its shareholders.
Many people think that each time a company pays a dividend, it’s devaluing itself.
They say things like, “Dividends don’t matter because the stock price falls by the exact same amount as the dividend on the ex-dividend date.”
Because of this, a lot of people seem to think that dividends are pointless… and certainly not something that can create wealth for shareholders over the long term.
This drives me crazy…
One of our core missions here is to identify “wide moat” businesses that pay reliable – and reliably rising – dividends. And I can assure you, that’s not a meaningless endeavor. But too many people think otherwise.
I admit, there are some very slow growth (or no growth) companies that are essentially transferring all of their cash flows to shareholders, meaning that the vast majority (if not all) of their total returns are generated by the passive income that they produce.
Oftentimes, because these companies don’t have fundamental growth, their dividends become unsustainable over time.
They get cut. Their share prices crash. And it’s a disaster for shareholders.
We call these “yield traps” or “sucker yields” at Wide Moat Research. And on this point, the Reddit army is correct. They should be avoided at all costs.
But…
Not all dividend payers are created equal.
Few Forces More Powerful
There are plenty of wonderful companies that not only pay dividends but possess strong fundamental growth outlooks because of smart capital allocation strategies that allow management to provide shareholder returns and still invest heavily in future growth.
This fundamental growth allows these stocks to reliably increase their dividends, year in and year out. There are few forces on the planet more powerful that compound interest and the process of constantly reinvesting dividends that are compounding organically can result in absolutely phenomenal returns.
These are the types of companies that we identify at Wide Moat. These are the types of stocks that I invest in personally. They’re the ticket that I’ve punched on my journey towards financial freedom.
Here’s a chart from my favorite institutional study on the matter, “The Power of Dividends: Past, Present, and Future” which is regularly updated by The Hartford Funds.
Source: The Hartford Funds
This might surprise a lot of people (especially Reddit users who love to bash dividends), but according to The Hartford Fund’s data, the best stocks in the world pay dividends.
This argument is clearly laid out in the table below.
The best-performing stocks in the S&P 500 are those that grow their dividends. They’ve beaten the market by a wide margin over the last 50 years.
Furthermore, they’ve done so with a lower Beta than the equal-weight S&P 500 index, showing that outperformance can be achieved with relatively low volatility. Yet, companies that pay stagnant dividends, or worse, companies that cut their dividends, underperform.
So, in a sense, the naysayers on r/Dividends got it right… or at least, partially so.
Buying into poor companies that cannot sustainably grow their dividends over time is a great recipe for underperformance in the market.
But what they’re missing is the fact that growing dividends offer a relatively low risk path to success.
You don’t have to look any further than the two largest companies in the world, Apple (AAPL) and Microsoft (MSFT), to see the success that dividend growth investing can create.
Microsoft is on a 22-year annual dividend growth streak. Over the last 20 years, MSFT’s dividend growth CAGR is 15.65%. And despite what r/Reddit might lead you to believe, Microsoft shares have done just fine since they started paying a dividend.
During the last 20 years, Microsoft has beaten the S&P 500 by a long shot. With dividends reinvested the stock’s total return CAGR during the last two decades is 16.83%, which compares favorably to the S&P 500’s 10.3% results.
To put this into perspective, $10,000 invested into MSFT shares on August 28, 2004, would have turned into $153,700 compared to just $56,800 in the S&P 500.
What’s more, with dividend reinvestment turned on, that $10,000 MSFT investment would have grown into $230,000 (compared to the SPY’s result on $72,400).
Apple began paying its dividend more recently, in 2012. They’ve increased it every year since.
As you can see below, since then, the company has returned nearly $900 billion to shareholders (via dividend payments and stock buybacks, combined).
Source: Apple Investor Relations
Once again, according to r/Reddit, a lot of this money has been “wasted.”
They’ll say something like, “The company should have invested all of this money to create growth and, ultimately, share price appreciation for shareholders.”
It’s a bit like saying Apple can’t walk and chew gum at the same time.
Since 2012, AAPL shares have produced a total return CAGR of 22.75% with dividend reinvestment turned on… nearly double the broader market’s 13.97% results.
Dividend growth investors can have their cake and eat it, too, when it comes to shareholder returns and capital appreciation.
No, dividends aren’t a waste of a company’s precious resources.
Actually, cash returned to shareholders by wonderful companies with growing fundamentals can – and will – serve as the foundation for a prosperous future for investors who are patient enough to let the compounding process play out.
That’s what we believe at Wide Moat Research. That’s what market history has shown. And that – in our humble opinion – is what every investor should aim for.
And don’t let anybody tell you otherwise…
Regards,
Nick Ward
Analyst, Wide Moat Research
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Source: Wide Moat Research