“When you’re going nowhere, anywhere’s a better place to be.”
- Harry Chapin, singer and song writer
We are not really in Mr. Chapin’s camp on this one, but we at Talbot Financial certainly understand the sentiment. On December 29, 2014, the S&P 500 closed at 2090. As we type this blog, the S&P is at 2085. The markets seem to be going nowhere and CNBC seems to be reaching to find any kind of excitement to fill their air time. In times past, there was term for this; it was called the doldrums, and this blog will address how dividends can be used to break those doldrums.
The word “doldrums” was popular among 18th century sailors who used it to describe the times when the trade winds didn’t blow, and sail-powered vessels were known to float aimlessly at sea for days (or even weeks). Laziness and apathy often engulfed the crew. It took a strong captain to keep his crew focused during these periods as boredom.
Right now, the markets are stuck in the doldrums and investor eyes are starting to glaze over.
According to Dana Lyons at J. Lyons Fund Management, Inc., by some measures the markets have been as calm as they’ve been in over a century. We have now gone 114 trading days (as of 6/8) without either an up 2% or down 2% day in the S&P 500. We would have to go back almost a decade to find a longer streak. So the next time someone says “today’s markets are too volatile,” you can smile to yourself knowing better.
At Talbot Financial we have always stressed that we don’t invest in the broad markets. Our investors own shares of individual stocks—and individual stocks commonly move 2% in a day. Still, this year’s relatively tight trading range, coupled with the lack of daily volatility and subdued volumes, have made for a “boring” market. Boring, however, does not necessarily mean unprofitable.
This is where dividend income comes in….and why they can be an investor’s best friend. A tip-of-the-hat goes out to Robert Shiller as well as the Goldman Sachs’ Global Investment Research team for the graph below that illustrates the power of dividends in a stock portfolio:
This graph tells a remarkable story. On a daily basis, the media draws our attention to how much the
Dow or S&P moves on any given day. Rarely, do they tell the story of the chart above. The untold story is how powerful dividends are to the total return of a portfolio over time. And the longer you hold a well-chosen company’s equity, the greater its historical contribution has been to your returns. Dividends do not normally remain stagnant in growing and cash-producing companies. Dividends grow, and it is this dividend growth that makes a huge difference in long term returns for equities (especially large cap) as an asset class.
Over the past five decades, S&P 500 dividends have grown on average 5.7% per year. This compares favorably to a 4.1% average inflation rate. That’s a 1.6% spread to inflation over that same period! Long term investors tend to look past the daily, weekly, or even yearly stock price moves and instead focus on how much income their portfolios have generated against their cost for the shares they own.
For example, let’s say today you were to buy a stock for $10,000 and those shares are paying a 3% dividend. The dividend yield to you would be $300/year. Let’s also assume that over the course of 10 years, management raises the dividend at the same rate as the long-term average of 5.7% per year. 10 years from now, your dividend income will be $522 per year. Your dividend yield-to-cost would then be 5.22%. That may not seem too impressive, but allow us to show you how powerful this can be by using Warren Buffet’s 1988 investment in Coca Cola.
When Buffett bought “boring” Coke 27 years ago, the stock was trading between $35 and $45 per share. The Price to Earnings (PE) ratio ranged that year between 14 and 19. Sales were down 2% year-over-year, and analysts were concerned that Coke was losing market share. Coke’s dividend yield was below 3.5%. Three stock splits and multiple dividend increases later, back-of-the napkin math places Mr. Buffett’s dividend-to-cost yield at over 43%. Do you know anyone who wouldn’t be happy with a 43% annual dividend?
There are times that fixed income can outperform equity strategies. This normally occurs when rates are very high and the Fed loosens and lowers rates over very long periods of time. We do not see that dynamic in either the short or medium term. In fact we believe, on balance, the opposite will occur.
But dividends don’t make good headlines. They are the supposed “windless-seas” of the investment world.
What is interesting though, is that doldrums at sea were often broken by a storm—and often times a dangerous one. When that storm would hit, the previously bored sailors now had to scramble for their lives as the waves and winds threatened to capsize their ship. Thus, 99% of boredom-time was suddenly punctuated by 1% of terror.
The same is true in the investment world. Doldrums can be broken by “storms” like 9/11, the dot com crash, the collapse of Lehman Brothers and other financial giants, and so on. The natural reaction is to cry, “All is lost!” Yet, the “strong ships” like Wells Fargo, Apple, Microsoft, Chevron, and hundreds of others have all proven themselves capable of weathering these storms. In fact, not only do they weather the storms, their ships recover and are retrofitted and improved. They use the storms to be stronger as seas calm. Plus, the crew emerges both smarter and more experienced. This is why over the long haul, solid stocks have risen….driven by their growth in dividends over time.
So, are we expecting a storm in the markets? Yes. There is always another storm. And just like 18th century sailors, we can scan the horizon all day and still not know when it will hit or how strong it will be. The point is, over the long term, storms come and go, but strong, well-built ships sail on. Strong storms may swamp the weak and rudderless ships—and new ships will take their place. That is capitalism. And, as we stated earlier, the strong ships will emerge stronger. Our goal is to identify those strong ships.
Fair Winds and Following Seas!