Published On: March 14, 2022
Written by: Ben Atwater and Matt Malick
In our last essay, we explored our broader investment strategy with an emphasis on how we manage portfolio income (scheduled withdrawals) during a difficult market, like the one we are now experiencing.
Today, we are going to continue along those lines, while digging a little deeper about stock dividends – a key component of portfolio strategy, income and total return.
The bull market that dominated most of the last ten years was primarily driven by capital gains, which nicely fund withdrawals in a rising market. But when the market falls, capital gains vanish or become less of a contributing factor to total returns.
Meanwhile, dividend payments generally continue whether the market is up or down. Additionally, under current law, the government taxes qualified dividends in a favorable manner just as they do long-term capital gains.
Historically dividends have been dependable. As an extreme and anecdotal example, we can look at one of our portfolio holdings, Procter & Gamble, a company that has paid a continuous dividend since 1891. Additionally, for sixty-five consecutive years, PG has raised the dividend it pays to its shareholders.
Another fun anecdote is that of Warren Buffett’s Berkshire Hathaway and the Coca Cola Company, another of our portfolio holdings.
Berkshire Hathaway owns four hundred million shares of Coca-Cola (KO), which now generate more than $670 million in annual dividend income. Buffett purchased these shares between 1988 and 1994 for a total of $1.29 billion. Since 1994, Berkshire has collected more than $9 billion in dividend income from Coca Cola, an amount rapidly approaching nine times Buffett’s cost (in just dividends). Meanwhile, the stock is worth an additional $20-plus billion. Coke might be one of the world’s most boring stocks and dividends might be a dry subject, but these numbers are nonetheless exciting in their own way.
Dividend stocks are not only helpful in a lousy market to produce reliable income and alleviate capital losses. They have also been historically helpful in inflationary environments.
A golden rule of finance is that a dollar today is worth more than a dollar tomorrow. This is particularly true in an inflationary environment. When inflation is high, interest rates also tend to rise. And in theory, a stock is worth the discounted present value of its future earnings. So, getting those earnings sooner (in the form of a dividend) when inflation is high theoretically increases the present value.
Dividends provide income and stability in a tough market; they allow us to value a company more easily; they reflect the long-term health and viability of a company; and they are an inflationary hedge.
None of this is new. Dividends have always been of tremendous importance. According to Standard and Poor’s, dividends have provided 32% of the total return on the S&P 500 since its inception in 1926. Today, dividends may be more vital than ever before.