Dividends

Our favourite topic, bar none; dividends. Dividends are the single most important source of shareholder value over the long term. They’re steady, real, and can genuinely fund your financial freedom dreams.

When a company earns money, they have a number of ways to reward shareholders. Two of the most common are paying dividends and through share buybacks. Dividends are a way of transferring earnings from the company directly to shareholders who then have the option to take the dividend or reinvest it back into more shares of the company. Share buybacks reduce the number of outstanding shares of a company and thus increase the per share earnings for remaining shareholders.

Today we’ll focus on dividends and some of their advantages:

• Consistency
• Inflation Protection
• Profitability Litmus Test
• Passive Reinvestment
• Alignment of Interests

Consistency

In companies where a dividend has been paid and preferably increased for many years, a dividend culture is created. Such a culture is important because it allows shareholders to gain confidence with management and a familiarity with how capital is being allocated. In a company with a strong dividend culture, decision making becomes simplified as there is no need to debate whether to increase the dividend, or whether a dividend should even be paid, but rather simply how much the dividend should be raised.

Among such companies, the board of directors are very reluctant to make cuts or changes to the dividend policy as this becomes a significant red flag that there are serious operational difficulties facing the company. Maintaining a steady policy allows shareholders to continue reinvesting in the company or simply maintaining their positions since they believe in a mutually beneficial shared future.

Inflation Protection

Inflation is the hidden tax that quietly eats away at the strength of every dollar in existence. As central banks print dollar bills to inflate the currency supply and as the prices of goods rise over time, those with savings in the bank realize a loss on their ability to even do groceries or fill up their gas tank.

As a very stark example of the ability of inflation to decimate the value of a dollar over time, think of The Coca-Cola Company (KO). You’ve probably seen the signs that show a single Coke beverage being sold for $0.05. For a comparable single-serve option today, an individual may be inclined to pay $2.00 or more! From a consumer’s standpoint, if they have savings in the bank but have not invested wisely, this increase could be costly. From an investor of Coke’s perspective, it would be easy to sleep soundly while sharing in the wealth through dividends.

Companies that annually raise their dividend and are able to do so at a rate above inflation provide protection to their investors that they will not lose purchasing power over time. As the cost of goods continues to rise, so should the investor’s dividend payments which in turn allow them to buy the same amount of basic goods such as food, shelter, clothing, and entertainment as they have in the past – if not more.

Have you ever heard someone say, “It costs so damn much to fill up the tank these days”, or “It’s too expensive to eat out much at restaurants anymore”? Of course you have. It’s the common refrain of the working person. All we say in the face of such comments is, “We just buy shares of the companies whose products we buy so we can offset how much the products cost by how much we receive in rising dividends.” Simple, eh?

Profitability Litmus Test

Anyone who has taken even a passing interest in the stock market and the corporate business world is accustomed to hearing about accounting scandals and the like. It seems every other week we’re hearing about a new investigation into practices of Big Business.

In such a shady environment, what certainty does the small investor have that they won’t have their hard-earned investment dollars wiped out in one fell swoop?

While there are no guarantees in life, dividends provide what we call the Profitability Litmus Test. A company may be able to fake profits for a while by sleight of hand in the accounting department and they may be able to artificially drive up their stock price as a result, but one thing you simply cannot fake is a multi-decade run of dividend increases.

Take a company such as Johnson and Johnson (JNJ) who has increased their dividend for over fifty consecutive years. Think about how difficult it would be for a company to somehow manage to do that without actually being incredibly profitable and well managed. It would be virtually impossible. Sending billions upon billions of real dollars to investors requires real profits. Doing so year in and year out for over half a century is actual proof that JNJ is a powerhouse.

Passive Reinvestment

Reinvesting dividends represents one of the greatest and simplest ways to compound wealth over time. It offers an opportunity to increase your stake in the company you’ve chosen while getting the advantages of a dollar cost averaging approach (buying regularly without trying to time the market).

The effect of buying high quality dividend paying stocks has three layers of wealth accumulation baked in:

• New money is used to buy shares of a dividend paying company.
• This company pays dividends to the shareholder who then passively reinvests the dividends into more shares which, of course, also pay dividends.
• The company annually increases its dividend which increases the size of the dividend payments in addition to the fact that more shares are already being purchased each quarter.

While some people reinvest the dividends directly into new shares of the same companies they already own, others prefer to allow the dividends to accumulate in their discount brokerage accounts and then make a lump sum purchase once enough money has built up. In either case, using the dividends you receive to build larger positions is simply intelligent investing.

Building passive income streams is one of the strongest ways to secure your financial footing. Think of a massive oak tree; the roots go into the ground in every which direction across incredible expanses. As the tree grows, the roots deepen and the foundation becomes even more solid. Improving your finances is no different – you need many deep roots branching out to strengthen you.

Alignment of Interests

What better way for everyone to get along than for everyone to make a profit? When companies pay dividends, they make it possible for shareholders to increase their positions in the company or maintain their current stake while still being rewarded for remaining loyal. This aligns the interests of shareholders, management, the board of directors, and the employees of the underlying company. When everyone has an opportunity to get paid, everyone’s interests are aligned.

With companies that do not pay a dividend, a shareholder has to sever the ties by selling shares to raise capital to fund their lifestyle. This creates a conflict of interest where investors are incentivized to hope for short term fluctuations upward so they can sell their stake and decrease their interest in a company. If someone is waiting simply for a favourable event so they can sell out, they are unlikely to have the best interests of the company in mind. That is true of people at all levels; whether investors, employees, or otherwise.

Conclusion

Dividends are one of the most important factors for investing success with the stock market. They get too little media coverage because the simple fact is that brokerage houses don’t make a whole lot of money when an investor patiently accumulates dividends and trades infrequently.

If you enjoy getting paid even while you sleep, take a vacation, or are out on the tennis courts, dividends are worth more than a passing glance.

Thanks for reading.

– The Get Rich Brothers

Do you invest using dividends as part of your Get Rich strategy? What do you love about dividends that we didn’t mention?

Full Disclosure: Long KO, JNJ

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