The following is a guest post from Mike, MBA and author of The Dividend Guy Blog where he writes about dividend investing. He is also the author of the book Dividend Growth: Freedom Through Passive Income US Edition.
“You can make a lot of money from the stock market.”
I’m sure you’ve heard something similar to this in your lifetime. You probably got all excited, opened a brokerage account and started investing. You were already thinking about the nice house you will build from your investing profits or the vacation to Hawaii that would be paid for by selling a few good stocks. This was until you received your first statement showing that you were losing 10% of your cash. Your dreams faded away and you then realized that making money off the stock market is not that simple. So… can you really make money from the stock market?
I’ve been investing for several years and meet with investors regularly as part of my work. The most successful investors I have met over the past 10 years all have their own investing strategies and their little trading secrets. But they share one thing in common: their love for dividends. After reading another guest post on FMF called “Dividend Investing is Not the Perfect Solution for Yield”, I wanted to share with you the reasons why successful investors choose dividend investing to build their core portfolio.
How About Making Double Digit Returns with Your Investment?
Would you believe me if I told you buying Coca-Cola (KO) will lead to a double digit return year after year? This is the case of several dividend paying stocks as they use the power of dividend growth to reward their investors. Let’s take a look at the KO example and you’ll understand. Let’s start with the KO dividend graph over the past 10 years (dividend payout is adjusted considering 2:1 split in August 2012). (Click image to enlarge.)
Since 1971 Coca-Cola has increased its dividend yield at an annualized rate of almost 10%. This means you double your dividend yield every 7 years or so. Back in 2003, the stock was trading around $22.00 (price value adjusted with the 2:1 split in 2012). The dividend yield back then was about 2%. Today, KO is now paying a quarterly dividend of $0.255 or $1.02 per year compared to a $0.11 per quarter back in 2002. The $1 dividend currently paid on an original investment of $22 per share represents a 4.64% yield.
If you had bought 1000 shares of KO back in 2003, you would have paid $22,000.
The share is now trading around $37.00.
Your investment is now worth $37,000. That’s a 68% investment return.
In the meantime, you have also received a total of $7,220 in dividends (or 32.81% total dividend return).
So in 10 years, you would have made a total profit of $22,220 on an investment of $22,000. That’s a 101% investment return for an average (not annualized) return per year of 10.1%.
The interesting part is that a third of your return is coming from the dividend. On top of that, you are now holding an investment paying a 4.64% dividend yield based on your cost of purchase. In another 10 years, chances are that you will be showing a 10% dividend yield if you keep holding this stock.
The Best Sign of a Solid Business Model
Besides the power of dividend growth, the fact of paying a steady dividend is a great sign of a solid business model for investors. When you find a company that has been paying a dividend for the past 10, 20 or even 50 years, you have a great indication (while not being a certitude) that the company business model is sustainable.
Since dividends are paid from after tax revenues, the company must ensure that it constantly generates a higher profit per share (followed with the Earning Per Share ratio) to be able to increase its dividend accordingly. A long dividend increase history shows you a responsible management team and a business model being based on solid assumptions.
As an investor, you can also easily follow what the company is doing with its profits as a part of them are returned back to you. It ensures that they don’t “waste” their money on irrelevant projects. By looking at the Dividend Aristocrats or Dividend Champion lists, you find solid and sustainable businesses that will continue to be in business for several years to come.
The Best Protection against Yourself
Do you remember how you went through 2008? What happened when you saw your stock portfolio drop by 30%? Did you panic? I can tell a big part of you did since everyone was selling on the market to go back into cash and bonds. Then you woke-up in 2013 and found that most of your losses had been recovered… but this is all on paper since you sold your stocks in 2008 and you will never see this money again.
Dividend stocks are usually less affected by major drops in the stock market. For example, I pulled-out five dividend growth stocks and compared them with the S&P 500 from Jan 1st 2007 to Dec 31st 2009:
- Chevron (CVX): +6.92%
- Procter & Gamble (PG): -2.29%
- Coca-Cola (KO): +22.71%
- Johnson & Johnson (JNJ): -1.21%
- McDonald’s (MCD): +40.24%
- S&P 500: -21.57%
This is a great example to show you that if you had held a dividend portfolio in 2008, you would have probably lost money but a lot less than by holding the S&P 500 index for example. During a stock market crisis dividend stocks usually:
#1 Continue to pay their dividend which reduces your loss
#2 Hold more investors on board which avoids massive stock value losses
#3 Prove their business models are among the most solid on the market
Think About Retiring With a Smile
In my opinion, I think the two major challenges we will face regarding retirement planning in the future is inflation combined with an aging population. Back in the 60s, we didn’t expect to live past 70 or so. Today, we retire around 60-65 and expect to live at least to 85. This means that you need a lot more money on the side to keep up with your lifestyle.
The problem is that once we retire, we don’t want to take risks anymore. We usually turn to CDs and bonds. Now that those investments don't even cover inflation, how can you expect to live 15 years longer with a portfolio that loses purchasing power each year?
By choosing stocks growing their dividend payout faster than the rate of inflation year after year, you can build a solid portfolio and live from your dividend payouts almost indefinitely. Your lifestyle won’t be affected by inflation since your dividends will increase every year to cover the rate of inflation.
Dividend Investing is the Way
On top of these 4 reasons why dividend investors are sucessful, I personally favor dividend investing for 3 other reasons:
#1 Dividend Investing is Easy to Understand – A prestigious financial background is not required if you follow simple and time-tested investing principles.
#2 Dividend Investing is Perfect for Lazy People – Not much time is required once you learn the basic principles of how to select your stocks.
#3 Dividend Investing, if done right, equals Receiving Money Monthly! – Dividend payouts are regular.
It’s obvious that simply buying dividend stocks is not enough to guarantee a good investment return from your portfolio, but I truly believe that this is the right place to start if you want to make money from the stock market.
Disclaimer: I own shares of KO, JNJ & CVX