In today’s financial world of extremely large buybacks and gargantuan price to earnings multiples on well-known growth stocks, there is still one place where an investor can experience real, concrete appreciation and that comes in the form of dividends. The main goal of individuals who work in the investment business should be to earn or compound money for their clients, customers, or shareholders. Too often, dividends are neglected and decisions are made to allocate capital to areas that do not benefit investors in the long run.
To highlight just how important dividends are to an investor’s return, let’s take a look at the historical return of the S&P 500 and the components producing the return.
Historic components of return in the S&P 500 (Shiller):
Dividend Income 4.4%
Real Div. Growth 1.3%
Valuation Shift 0.7%
Total Nominal Return 9.7%
Dividends and dividend growth account for 59% of the historic return from large cap stocks.
Note also that inflation is now running at 1.5% to 2% so it is providing a much lower contribution to return and dividends and the growth of these dividends loom larger in the expected return from stocks.
Great investors throughout history have understood the importance and impact that compounding interest and dividends can have on their personal wealth as well as philanthropic causes. Benjamin Franklin, knowing the power of compound interest, instructed part of his estate to go to the cities of Boston and Philadelphia and to be held for at least 100 years in investments that would pay 5% or more and compound over that time. Both cities realized the impact of this strategy as it resulted in their receiving millions of dollars after 100 years from a start of only 2,000 pounds at Franklin’s death.
There are many things that seem intangible and illusive in the stock market, but dividends are tangible and with their historical importance to return should be utilized in planning for the future. To illustrate the importance of dividends and compounding interest, here are two quotes from successful and well-known businessmen and financiers:
“I don’t know what the Seven Wonders of the World are, but I do know the eighth – compound interest.”
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”
-John D. Rockefeller