Editor’s Note: We begin today’s Daily with another classic piece from Tom. It has just as much importance as when he first wrote it in 2011…
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From Tom Dyson, publisher, Palm Beach Research Group: “Dividends don’t matter.”
I was playing golf with a stock trader last weekend. When I told him I specialized in stocks that pay dividends, he gave me a look of condescension.
“I don’t understand what the big deal is with dividends,” he explained. “The stock falls by the amount of the dividend, so you can’t benefit from it. Total return is the only thing that matters.”
On the surface, my golf partner is right.
A dividend is simply a cash payout from the company to the shareholder. Whatever the shareholder gains, the company loses. So it seems shareholders don’t actually come out ahead.
But as I’ll show you today, to say cash payouts like these don’t matter is wrong. They improve returns by thousands of percent over the long term.
My friend Meb Faber proved this to me the other day…
Meb is a professional stock market number cruncher, or as he calls himself, a “quant.” He’s used his skills to create some incredible investing strategies. (You can read more about them here and here.) He also launched an ETF (the symbol is GTAA) so you can follow his system with just one click.
Meb recently crunched the numbers on dividends and other cash payouts and found something amazing.
He started with the Russell 3000, an index of 3,000 small-cap stocks: Since 1972, it gained 9.98% per year on average.
But when Meb isolated the top 10% of dividend payers, he found they returned 13.29% per year… an improvement of more than 3% over the common index.
Meb didn’t end his study there…
When most people think of companies returning cash to investors, they think of dividends. But there are two other ways a company returns cash to shareholders.
Stock buybacks are the first way. A company might decide to pay shareholders by buying back its own stock in the open market. To an accountant, it’s an identical transaction as a dividend. Cash leaves the company. Cash goes to the shareholders.
The difference is, instead of sending each shareholder a check for, say, $100, the company causes the investors’ stock to rise in value by $100.
The shareholder has a capital gain instead of a cash income, but the result to the shareholder is the same.
The second way a company returns cash to shareholders without paying dividends is by paying down debt. Cash flows from the company and accrues to shareholders, just like a dividend. In this case, the cash pays off a bondholder who has a senior claim to the stockholder. Once the bondholder is out of the way, the shareholder is that much closer to the future profits.
When you include these two additional ways companies return cash to shareholders, you get the true “cash” yield to shareholders. Meb calls this the “shareholder yield.”
Meb repeated his study on the Russell 3000, taking total shareholder yield into account. This is what he found…
Earning 9.98% over 38 years turns $1,000 into $37,147. Earning 16.93% per year over 38 years turns $1,000 into $381,229.
In other words, over 38 years, that annual difference of nearly 7% would have increased your total return by 926%.
The conclusion is, my golf buddy is totally wrong. Stocks that pay out cash generate far higher returns than stocks that don’t.
If you’re investing for high returns and are ignoring stocks that pay out cash to shareholders, you’re missing the point. You should almost always favor companies that pay out cash to investors over those that don’t.