Years’ worth of dividends – the most useless metric ever – ValueWalk Premium
Stocks

Years’ worth of dividends – the most useless metric ever

Some investors get absolutely furious the second someone mentions the term yield on cost. I am very surprised when investors seldom have anything against the metric for “years worth of dividends received”. This metric is usually mentioned during a situation when an investor is sitting at a healthy gain after having purchased a stock at much lower prices. The saying goes that if this investor sold, they could obtain several years worth of dividends by simply realizing their capital gain.

Q4 2019 hedge fund letters, conferences and more

Stocks

geralt / Pixabay

This metric is typically used to justify selling a good company at a (what is believed to be at the time) high price. Investors who focus only on capturing “several years worth of dividends” through the gain on their investment, are treading in dangerous waters. This could lead to them cutting short the profits on the stocks they purchased, and holding on to companies that might not be performing as well, especially if they haven’t delivered any gains.

I am not a fan of selling companies in general, and subscribe to a philosophy of buying and holding, and doing nothing else. Selling is usually a mistake, compounded by the fact that the next company usually does worse than the original investment sold. The mistake is further compounded by taxes paid, and commissions. Patience is important is long-term investing. My largest mistake has been selling for any reason, on average. Of course, I have been forced to sell with buyouts, and with dividend cuts, but any other reason has been a mistake. It has been a mistake for most other investors as well on aggregate, despite the “good reasons” they may have had.

Cutting the tree that produces fruit is never a good idea, especially if you replace it with a tree that might grow faster and is much bigger, but has a higher risk of catching a disease and dying.

I think problem is that this metric ignores capital gain contributions to total returns. This metric also forgets that a company that can grow dividends and earnings could end up paying more dividends down the road than a company with a higher dividend that is static. I have also found out that companies that can manage to grow earnings over time are less likely to cut dividends.

It is true that you can sell a stock that generates $100/year in dividends purchased at $1000 for a $2000 gain. But what you are missing out is that you locked dividends “for 20 years”, but might have missed out on future appreciation and dividend income growth. While it is secondary to income, appreciation potential is important as well.

As investors, we do not know in advance whether the company we are buying with the proceeds will do better than the company that you just sold at a gain worth”several years worth of dividends”. The problem is further magnified by the fact that we end up teaching ourselves to trade the portfolio actively, which could result in missed opportunities, investing costs (taxes and up to 2019 commissions) and time. Your goal as a dividend growth investor is to assemble a portfolio of quality blue-chip companies to hold for the long-term. These are recession resistant businesses that will pay you more money over time. Your goal is to hold them, not trade them actively, which is something that few can do with any consistent success.

The years worth of dividend sold saying bothers me, because it reminds me of the useless saying that “nobody went broker taking a profit”. The issue with this saying is that noone became rich by constantly taking profits. By constantly cutting the flowers by selling your winners, and watering the weeds by adding to your losers, you are guaranteeing yourself a life of investing mediocrity.

I view myself as a farmer, who plants lots of seeds in the ground, hoping that a few will be big enough winners to compensate for the seeds that turn out to be rotten. That’s why I diversify, buy over time, and try to hold for as long as possible, in order to break-even and then earn a profit over time.

I will try to illustrate the ridiculousness of the saying behind “years worth of dividends” with an actual example from my portfolio. This is Brown-Forman, which became a dividend aristocrat in 2009, after raising dividends for 25 years in a row.

Back in 2010, I purchased shares of Brown-Forman (BF.B) for a split adjusted cost of $15.99/share. The company was expected to pay 32 cents/share, for a roughly 2% yield. I also received a special dividend of 26.67 cents/share – Brown-Forman is a shareholder friendly business, that is recession resistant, and is backed by a family whose fortunes are dependent on this business growing.

By the end of 2011, the stock was selling at $19.84/share, the stock had paid 35 cents/share and I had 11 years worth of dividends in appreciation.

By the end of 2012, the stock was selling at $24.83/share, the company had paid 38 cents/share in regular dividends and $1.60/share in special dividends.

In 2013, the stock closed at $29.66/share. The company paid 42 cents/share, and my gain amounted to over 32 years worth of dividends. Should I have sold by then? I was asking myself this question at the time, as the stock was selling above 20 times earnings and other companies were selling for less than that. Had I sold, I would have altered the risk profile of my portfolio, and I would have likely reached for yield that would have temporarily increased dividend income, but ultimately left me with less dividends over time.

By 2014, I was reading how great Brown-Forman was, which pushed the price up to $34.84/share. I received a little over 47 cents/share, and my gain was equivalent to 40 years worth of annual dividends. The stock was yielding roughly 1.50%. I could have sold it, and bought Con Edison at $68.50/share and a yield of 3.70%. That would have more than doubled dividend income. Con Edison would go on and pay $13.86 in dividends through 2019, and its share price would go on to $89.94/share ( or 7 times annual dividends at the annual rate of $2.96/share – my head hurts from this circular thinking). I wrote the prolific article, after a reader question – Should you sell after yield drops below minimum yield requirement?

In 2015, Brown-Forman’s share price reached $40.05/share, the dividend paid was a little over 51 cents/share. At an unrealized capital gain of 47 years worth of dividends, I should definitely reconsider this, right? After all, there is a high chance that I won’t be around by 2062. But I keep on holding on.

By the end of 2016, Brown-Forman sells at $35.21/share. The company paid a dividend of a little over 55 cents/share, but the yield is still low at 1.56%. My yield on cost is 3.40%, which I could have easily achieved by selling and switching to Diageo (DEO). Of course, if I sell today, I would pay a tax on my capital gains, and have $32.33/share after tax. Now I am down to only 35 years worth of dividends. Perhaps I should have just cashed in those chips, right? I was watching Brexit, and hoping that Diageo (DEO) would fall below $100/share – the problem was that the stock did not go down. Which in hindsight was great, since I didn’t get to sell Brown-Forman. I just added to Diageo with new cash later.

By 2017, I am really glad I didn’t sell, because Brown-Forman is now selling for $54/share and paid almost 60 cents/share in dividends to me. That’s a P/E of 39.40, and a yield of 1.10%. I have an unrealized gain of 63 years worth of dividends. However, there are clouds on the horizon. Constellation Brands (STZ) wants to acquire Brown-Forman, but is rejected. I realized that having quality companies I own get acquired is a real risk behind dividend investing, that noone talks about.

It is 2018, and the stock is down to $47.58/share, but the company has paid 64 cents/share in regular dividends and a dollar per share in special dividends. The stock is at 32 times earnings but I keep holding on. Oh wait, the gain is now only 49 years worth of dividends, down from 63 years worth of dividends in 2017.

I am writing this post at the end of 2019, with Brown-Forman sitting pretty at $67.94/share. The company paid a dividend of 67 cents/share, and the forward annual dividend is at almost 70 cents/share. That’s 74 years worth of dividends, for the lucky reader who made it to this paragraph. Your meticulousness and attention to detail would be rewarded with successful long-term dividend investing. Let’s talk again in 2093 about that.

I have recovered a little over 42.50% of my original purchase price with dividends alone. If history is of any guidance, I expect more earnings growth, which will trigger more dividend growth, and growth in the intrinsic value of the company. I would continue holding on to the stock, which is at 37 times forward earnings.

Earnings per share increased from 81 cents in 2009 to $1.73/share in 2018. The company is expected to earn $1.82/share in 2019. While we may argue that the valuation is very high at 37 times forward earnings, we should not forget that we are discussing a high quality asset. If Brown-Forman were to be acquired, it would most probably be taken over at 30 – 32 times earnings.

Those earnings will likely double every decade. Therefore, for a long-term investor with a 30 year holding period, you may do just fine. At 7%/year, the earnings per share for 2049 could jump to $14/share. At a P/E of 20, this translates into a share price of $280. If dividends per share also grow by 7%/year, Brown-Forman will pay $5.30/share in 2049. You would have collected almost $71 in dividends during the span of these 30 years. The multiple compression will be a headwind to returns in the first few years of holding the stock, so this will affect investors who lack patience and bail out after “the stock goes nowhere for extended periods of time”.

Not every company will reward you as well as Brown-Forman. But on average, a diversified portfolio of dividend aristocrats, held for the long-term, would likely surprise on the upside in terms of dividend income growth and capital appreciation.

I focus on companies that have competitive advantages, which will allow them to generate higher earnings over time. This will translate into more dividends for me. Some companies may end getting sold, due to an acquisition or a dividend cut, but I will hold until then. I have learned the hard way that selling for any other “reason” is usually a mistake.

I could sell Brown-Forman today, and get 74 years worth of dividends from my capital gain. Actually it will be lower, around 63 years, because I would have to pay a 15% tax on long-term capital gains if I sold. By selling, I would be losing on the future inflation adjusted stream of dividends provided by this dividend champion. The company is led by a shareholder friendly management, as evident by the special dividends, the growth of earnings and the dividend track record. I can always buy into Diageo, which is cheaper, but whose growth is lower. Plus, Diageo has a lower chance of getting acquired.

Theoretically, I could replace Brown-Forman with is cheaper one that has a higher expected growth. But I would alter the risk profile of the portfolio that way. And I would not know if the other company is cheaper because it is more cyclical, or because its growth would be non-existent down the road.

Thus, focus on quality, and hold on to it.

Relevant Articles:

Article by Dividend Growth Investor


X
Saved Articles
X
TextTExtLInkTextTExtLInk

0