Dividends Are A Return Of Capital And A Return On Capital

umbrellaDividends Reduce Risk

I often espouse the benefits of investing in companies that regularly pay and raise dividends. Of course, there are a number of reasons I do so, and I try to share these reasons as much as possible.

Today I’m going to show you how dividends reduce risk by functioning as both a return of capital and a return on capital.

There’s a difference between the two, but how does that work?

A return on your capital is simply a return on investment (ROI). You invest money in something that produces a return, and that return is your ROI. It doesn’t matter if this investment produces income or simply appreciates in price. Let’s say you buy a stock that pays no dividend:

You pay $1,000 for 10 shares of ABC Company at $100 per share. A year later you sell your 10 shares for $1,200. I’m going to leave out taxes and commissions for the sake of simplicity. So the $200 profit from the sale is your ROI. That’s a 20% return over the course of one year, which isn’t bad at all. Repeat that over and over again and you should do well.

Now, that scenario worked out pretty well. You likely had to stomach some ups and downs in the meanwhile, but all of your initial capital was returned to you, with a nice profit to boot.

But what happens when that asset doesn’t appreciate?

Let’s say you bought those same 10 shares ($100 per share) of ABC Company for $1,000, but a year later the company announced something Mr. Market didn’t like and those same 10 shares are now worth only $800. You decide to sell on the news as the fundamentals have changed and you net a ($200) loss on your investment. So you just took a 20% haircut, meaning your ROI is -20%. You not only didn’t receive a profit, but you also took a loss on some of your capital. The capital you now have to reinvest elsewhere is smaller.

Dividends Act As A Buffer

Stocks that do not pay any dividends means your returns are completely at the mercy of Mr. Market. I like to say dividends act as a kind of “buffer” between the market and your capital, and that’s because dividends flow directly from a company to you as a shareholder. They bypass the stock market altogether, and so that’s why you’ve got this interesting relationship going on where they function as both ROI, but also a return of your capital.

When you invest in a company that pays a dividend (even better if they raise it regularly) you’re receiving capital directly from the company. No matter what happens to the company’s stock price, that company is sending you money back. Slowly the capital you initially invested with the company is being directly returned to you in the form of regular dividend payments. So the share price may oscillate wildly affecting the eventual outcome of your ROI (if you ever sell), but your risk is being reduced one dividend check at a time because the capital you initially invested is slowly being returned to you. Eventually, if you hold on to the investment long enough and the company continues to pay dividends during that time frame, all of your capital will be returned to you, meaning any share price appreciation comes with essentially no risk on your part.

Even while dividends do affect your total return as they’re added on to any capital gains you may or may not receive, they also function as a return of your capital as a company you buy shares in sends you regular dividend payments.

So let’s get back to that earlier example, using the first scenario. This time, ABC Company pays a $3.00/year dividend per share (3% yield).

In the first circumstance, you seen the share price appreciate from $100 to $120, but now you also collected $3.00 per share in the form of a dividend. So your ROI was boosted slightly to 23% – 20% from capital gains and 3% from the dividend. In this scenario, you collected $3.00 per share directly from the company and $20.00 per share in capital gains. So not only are you left with $1,230 when all is said and done in terms of your total return, but the $30 you received directly from the company means the capital you had at risk, even if the company went bankrupt, is only $970.

Do you see how that worked? 

Real-Life Example

If you didn’t understand quite how that worked, I’m going to use a real-life example to illustrate my point. And I use this example because I work better with real, working models. Hypothetical examples are nice, but anyone can massage numbers to make their point.

Philip Morris International Inc. (PM) is the second largest investment in my personal portfolio.

I accumulated shares in this tobacco giant over the course of three years, starting in January 2011 and my latest purchase coming in January 2014.

I’m including a screenshot directly from my Scottrade account so you can see accumulation in action:

PM

I spent $7,927.55 of my own capital in my accumulation of 115 shares.

Of course, it’s wonderful news that these shares are currently worth $10,147.02 (as of this writing).

But you know what’s even better?

I’ve received a total of $860.25 in dividends during my ownership tenure.

That means my return on capital is boosted, as the total return on my capital isn’t calculated from the difference between $10,147.02 (current position value) and $7,927.55 (cost basis) – which would be 28%. Rather, my total return is calculated from the difference between $11,007.27 ($860.25 + $10,147.02) and $7,927.55 – which would be 38.8%.  So my ROI is higher than it might look on paper due to the dividends I’ve received over the last three years.

But there is also a return of my capital.

See, no matter what happens to Philip Morris from here the capital I have at risk right now is only $7,067.30, and that’s because Philip Morris has sent me checks that total up $860.25. It doesn’t matter what Mr. Market might think of the company and its future prospects, the business itself has sent me capital. Eventually, if I hold the position long enough and they continue paying dividends, Philip Morris will send me so many dividend checks that they will add up to more than I initially invested in the company. At that point, my capital on the line is essentially $0. The company could go completely bankrupt at that point, and I still would have technically lost nothing. In fact, it’s quite possible with a business that pays you dividends long enough that even if it goes bankrupt and you hold all the way through bankruptcy (an unlikely scenario) you would still actually end up with a positive return. Imagine that!

Conclusion

This is a fantastic aspect of dividend growth investing that is rarely discussed, as I truly believe that dividends reduce risk as they function as both a return on capital (your ROI) and a return of capital (leaving less capital on the table). This allows you to slowly reduce your original capital’s exposure to Mr. Market’s madness, and over time could possibly leave you with none of your capital at risk, even while assets continues to churn out regular dividend payments to you while the equity ownership shares continue to also appreciate in value.

Of course, there are detractors to this belief as they may point out that any dividends that do not leave the company’s coffers could potentially leave the company in a better financial position and that capital could be invested elsewhere, propelling the share price by an equal amount. But I don’t invest for coulda, shoulda, woulda. I invest for real-life cash flow. And my Philip Morris example shows you not only how dividends can boost return on capital, but also return your original capital back to you in small pieces, essentially reducing your risk (via capital exposure) with every passing payment.

Full Disclosure: Long PM.

How about you? Do you believe dividends reduce risk in this way? 

Thanks for reading.

Photo Credit: bplanet/FreeDigitalPhotos.net

Note: Scottrade link is an affiliate link.

Comments

  1. says

    You’re right Jason. Most people gloss right over the fact that your investment is being returned to you, with each dividend. I did have a friend that lowered his cost basis, with each dividend…..but I wonder if he took taxes into account. Too much hassle for me. I’m just glad money flows the RIGHT direction.
    -Bryan

    • says

      Bryan,

      Well, your friend can do that on for his own records, but for tax purposes the cost basis wouldn’t be affected like that. Unless we’re talking about a different corporate structure like a REIT or MLP. Those payments are sometimes classified directly as a return of capital, which legally affects your cost basis.

      But I agree that most people do gloss over the fact your investment is being slowly returned to you via each dividend payment. How could you not love that??

      Thanks for stopping by!

      Take care.

      • says

        Haha, I didn’t intend to mislead anyone. Your clarification is spot on for taxes…..I just ment he goes through this little exercise for his own amusement. After enough dividends, he’s playing with the houses money…..which I think was what you were getting at. Have a great day
        -Bryan

  2. says

    Fantastic article, as always! I agree as well; in theory, if you waited out long enough, the dividends paid out would cover the cost of your initial investment, which would then mean even better in terms of percentages! Definitely going in the right direction :) your writing is so clear and concise too, it’s so helpful.

    • says

      Nicola,

      Thanks for the compliment! I appreciate it, and glad you find the writing clear and concise. I do try to make these concepts approachable and understandable. :)

      Once your initial investment is completely covered the gains from there are all gravy. And I like gravy!

      Best regards.

  3. says

    This is exactly why I sleep better at night whit a portfolio full of dividend paying companies, than I would have with non-dividend paying companies. The knowledge that every month I can expect a healthy paycheck irrespective of what the market as a whole does, makes it a lot easier not to panic in those tough moments where a companies share price falls with 35%. My initial investment is slowly being returned to me irrespective of the share price.

    best,

    DW

    • says

      DW,

      I’m with you. It’s all about sleeping better at night, and I currently sleep like an absolute baby knowing that more cash continues to hit my account regardless of what mood Mr. Market finds himself in.

      It’s a great position be in. :)

      Cheers.

  4. Aspenhawk says

    Thanks Jason for the right way to see things. Most very rich people use this strategy and want to be paid for giving their money to a company. They want to be paid for waiting. Who would lend money without interest ? The best part of dividend growth investing is that it gives me a spirit of collecting like I would collect paintings, cars, or watches, who knows ? And the best of all is that after 5 to 7 years or so holding to a good corporation, the dividends grow and form a kind of snowball. Very interesting post ! Thanks again for your passion.

    • says

      Aspenhawk,

      Thanks for stopping by!

      I’m with you. I’d never want to put my capital at risk without some kind of cash payment coming my way. Cash makes the world go ’round, not promises. Relying only on what the market wants to price your investment at, in my opinion, is really putting yourself out there.

      Take care.

  5. Greg says

    Thanks for providing another way to look at the benefits of dividends. I think everyone is familiar with the chart of the historical return of the S&P 500 with and without the contribution of dividends, but this provides a clear picture at the level of an individual stock.

    I set up a spreadsheet starting with a column showing the out-of-pocket cost (for the shares and the commission) of each stock in my portfolio. It also has a column for the cost basis (cost of shares, commissions, and dripped dividends) and market value. The difference between out-of-pocket cost and cost basis is distinct for my ShareBuilder account due to their pseudo-DRiP function. There is no difference between those values for my Scottrade account as they accumulate dividends in the cash balance. Those accumulated dividends get incorporated with new capital for selective reinvestment in the same or a different stock. So, their contribution seems to “disappear.” In other words, there wasn’t a quick and tangible way to see them at a glance. Until now,…

    Your return of/on capital system provides a way to do that. I can go to sleep tonight a little smarter than I was this morning.

    • says

      Greg,

      Glad this post made you think about the power of dividends in a new way.

      And speaking of historical return of the S&P, I ran into this study by John Bogle (yes, Vanguard’s Bogle) on reinvested dividends a little while back:

      http://www.etf.com/publications/journalofindexes/joi-articles/3869-the-importance-of-investment-income.html?iu=1

      I quote:

      “Consider this: An investment of $10,000 in the S&P 500 Index at its 1926 inception (Figure 2) with all dividends reinvested would by the end of September 2007 have grown to approximately $33,100,000 (10.4 percent compounded). [Using the S&P 90 Stock Index before the 1957 debut of the S&P 500.] If dividends had not been reinvested, the value of that investment would have been just over $1,200,000 (6.1 percent compounded)-an amazing gap of $32 million.

      Over the past 81 years, then, reinvested dividend income accounted for approximately 95 percent of the compound long-term return earned by the companies in the S&P 500. These stunning figures would seem to demand that mutual funds highlight the importance of dividend income. But in this era of ”total return,” income is virtually ignored.”

      Onward and upward! :)

      Best wishes.

      • Greg says

        Thanks for the reference. I found a few more gems:

        “When we take inflation into account, the importance of dividend income is magnified even further (Figure 1). ”

        “…it’s high time that we require mutual funds to disclose to investors and prospective investors the amount of their dividend income that is consumed by costs, and its impact on the fund’s long-term returns.”

        The second excerpt makes one wonder how much income and capital is eaten away within the “black box” of many mutual funds. It pays to educate yourself.

        • says

          Greg,

          Glad you enjoyed that article by Bogle. I remember a Boglehead emailing me a while ago, touting the benefits of index investing and advising me that investing for dividends is just dumb.

          I agreed that index investing is better for the majority of investors, but I also shared that article. I remember disbelief and the guy basically saying that Bogle didn’t really mean what he was saying, and his words were twisted. Funny stuff.

          Take care!

  6. says

    I like to keep track of my payback for each position in a separate spreadsheet. I’ve got some pretty nice ones so far considering I haven’t been investing for all that long it’s pretty cool to see some that are over 10% already. Something people seem to forget is that the dividend is always a positive factor of return for your portfolio. Whereas the value of the underlying position can vary wildly. It’s those consistent positive returns that add up and can really lead to amazing results when reinvested.

    • says

      JC,

      Couldn’t agree more. The dividend is always a positive return, which is something that Mr. Market cannot always guarantee. And as I was mentioning elsewhere, reinvested dividends account for almost all the total return of the stock market over the long haul. Can’t argue with that!

      Cheers.

  7. Anonymous says

    Hey DM,

    I have a question. How did you get that free trade on Scottrade? I also have an account there and I was told that they will give you free trades sometimes if you bring in (i.e. deposit) a relatively large amount of money. But they also told me that if I requested the free trades, I might not get them, because I’m not TOO active of a trader (in other words, like you, I buy and hold, so I don’t generate THAT much in revenue for them).

    I would love to find out more, since I do place trades on a more or less monthly basis.

    Thanks.

    • says

      Anonymous,

      It’s been a while, but if I remember correctly that free trade was a result of a survey that Scottrade had going at the time. I think I received three free trades as a result of completing it. I will also occasionally receive free trades if I refer someone to Scottrade.

      I hope that helps!

      Take care.

  8. says

    Great article. Very simple and plainly put of a subject that is way overlooked in investing. Mr market often does not affect dividend payouts so it forces you to hedge your investment bets in good markets or bad markets. Nothing worse than a huge crash decimating your stock value by 50% but a constant dividend stream allows you to pull money out of the market without selling off. In fact dividends discipline investors into reinvesting in any market condition. Dividends keep people glued to watching stock performance and company news and if a dividend gets cut you will know quickly. Also Dividends keep you from getting too caught up with loss aversion as most investors will sell if dividends are fully cut or reduced.

    Good Day and Grind On!

    • says

      Asset-Grinder,

      You make some great points there. Dividends keep the focus on a company’s fundamentals because you know it’s the company paying you. Stock prices keep you fixated on the stock market. I’d rather focus on a company and real-world sales than a stock market that is subject to the whims of human emotion and complex computer algorithms.

      Best regards.

  9. says

    You put it very well. This is the reason why I am investing in what I am investing Beginning of 2014, People on CNBC-TV predicted 10 year yield would be 3.80 in the end of the year. that became 3.50, now 3. I thought that they were out of touch with main street. My prediction was 3%, even this 3% will take a while to get there, if it does get there. I started investing based on my prediction in January 2014, It worked like a charm. I don’t think, I had many bad days since January. I’m high these days cause my monthly dividend amount is very high and funds price went up through the roof. I can’t refrain myself from writing, every time you mention about dividend. It is my favorite subject. Good luck to you.

    • says

      Young,

      CNBC is crazy. I haven’t had cable in years, and so the only times I would really catch CNBC was at work sometimes during a lunch break. But I now have access to cable television since my sister has it here at her home. And the stuff they’re talking about all day long is just nuts. It’s truly nothing but noise – so I use it as background noise while I write and research. That’s really all it’s good for.

      Cheers!

  10. Paapaa says

    I actually disagree a bit…

    1. Dividends are really no extra money. When company pays dividends, the money is transferred from company’s account to yours. This really lowers the market value of the company as much as dividends are paid. This is very important to understand. Dividends are only money from one pocket to another.

    2. It really would not make any difference what so ever if the company bought it’s own shares instead of paying dividends. You can then sell some of your stocks to generate equal cash flow and having equal share of the company.

    Taxes and fees are the only thing that make a difference.

    I like passive income and dividends – don’t get me wrong. But dividends are never anything extra and the company always loses the ability to invest the money it pays as dividends. And if I reinvest to the same company, it is more tax efficient to never pay the dividend in the first place.

    • Zol says

      I hope you don’t read seekingalpha because this has been a hot button topic, lots of good discussions i don’t want to rehash here. I don’t want to poke the tiger :)

      • says

        Zol,

        My last paragraph was directly aimed at the detractors of these concepts, because SA is full of them. I generally don’t engage them because there is really no point. It’s a fruitless exercise, so if they show up after SA republishes this article I’ll most likely ignore them.

        Best regards!

    • Debbie M says

      It’s nice to get money without having to sell any shares or pay any fees and you can use that money as income or to diversify your investments. I’ll admit that when it goes right back into the same company, it’s not as good, but you can often set up drips for that so that you don’t pay fees.

      • says

        Debbie M,

        Well, that’s why you diversify. If you have 30-50 compounding machines churning out rising dividends for you the odds are very low that more than one or two of these businesses will go bankrupt during your ownership tenure. And if they do start to go down that path you should be able to see the corner coming.

        And avoiding commission fees to sell tiny equity positions to pay for your expenses is just but one benefit of this strategy.

        Thanks for stopping by!

        Best wishes.

      • Paapaa says

        True. We don’t have a proper DRIP program in Finland and our dividend tax is veeery high. So I don’t mind buying stocks with not that high payout ratio.

    • Ravi says

      True and false.

      You are ignoring the value of “signaling” that dividends/buybacks help investors infer about management and the future of a company. Of course, this value is relative to the industry, stage of life cycle, etc. It would be strange for a fast growing tech company to pay a dividend, but normal for a slow growing telecom company. You also have to consider risk, since there are plenty of companies paying 10%+ dividends, but you need to consider the sustainability of that dividend.

      In an ideal world, there would be no dividends and management would ALWAYS reinvest at the highest and best use. But, since when does that ever happen?

      • Paapaa says

        Well said. It all depends. I like dividends, but I don’t blindly praise them in all possible situations.

    • says

      Paapaa,

      I could go on and on as to why I don’t believe your premise to be correct, but just like you won’t convince me of your concept I won’t convince you of mine. So why waste the time? :)

      Best wishes!

      • Paapaa says

        Of course it is not waste of time! This is why comments-section exists, right :D And I’m only for civilised discussion. Don’t want to engage to a flame war. And I don’t need to convince you – I’m just expressing a different view. I always think that proper arguing is a good thing.

        Aside form transaction costs and taxes (which are very important factors and vary) it is not easy to claim that dividends are better than share repurchases. Both can generate cash flow, both let the investor to decide if they really want to reivest the cash or if they want just cash for themselves. Both allow the same identical final situation.

        I agree that if the company just deposits cash to low rate account (without investing to core business), a dividend/repurchase would be a lot better. And in general I think the best thing is that some money goes to dividends, some goes to repurchases and some go to investments. Of course, in some market situations this can be changed.

        I live in Finland and our dividend tax is very high. This country does not support buying stocks… So I don’t mind buying firms with low payoutratio and high repurchase ratio. We also don’t have DRIPs. If the dividend tax was 0% I would always prefer dividends, of course. (Unless the company can reinvest the money better)

        Anyway, I don’t like that dividends are always better and I don’t think one should “blindly” just look for dividends. Diversification is a good thing here too: buy some dividend aristocrats, but also some different kinds of fims.

        BRK is a great example of a firm where dividends have not made much sense. Nobody can claim that the decision has been a bad one.

        • says

          Paapaa,

          “Aside form transaction costs and taxes (which are very important factors and vary) it is not easy to claim that dividends are better than share repurchases.”

          Not true. It’s quite easy. What about executive compensation? What about gross share buybacks against net buybacks?

          Returning capital directly to shareholders allows you to do with that capital as you please. I have a view that human beings are naturally a greedy sort. Allowing a group of individuals billions of dollars to play with at any given time could create…issues. Furthermore, you have to know that the person running the ship ALWAYS knows where to go with excess capital. They may have good ideas from time to time, but always? I used Coca-Cola and their $5 billion on annual dividends as a good example. I personally wouldn’t know where to go with $5 billion every year to increase returns to make up for the additional equity. And Coca-Cola is already under heat for executive compensation. Now we give them $5 billion more?

          As far as your situation in Finland, that makes sense. If our dividend tax was raised significantly, this would make dividends much less attractive. You have to play the hand your dealt. If I lived somewhere else I’d play the game the best I could there with the rules at hand. The system here in the U.S. allows one to successfully build a nice dividend income stream with relatively low taxes, but this isn’t true everywhere else.

          As far as BRK, this is one of the few exceptions to the rule. There aren’t Warren Buffetts all over corporate America running companies. He’s a very, very unique investor, so I would absolutely agree that Berkshire has been much better off retaining excess profits and reinvesting as Buffett has done. However, even Berkshire isn’t immune to criticism in regards to its dividend policy. There has been a clamoring recently for the company to start paying a dividend because they’ve trailed the S&P 500 over the last few years, and shareholders want to start getting their hands on that cash. I think you’ll see that business start to pay a dividend within the next decade or so – after Buffett is gone. And that’s simply them admitting they can’t do better with the capital than shareholders potentially could, and even Buffett has admitted that investors with smaller bases of capital can do much better than he can due to their flexibility.

          Cheers!

          • Paapaa says

            I think executive compensation is separate matter. I wouldn’t mix it to this issue. Compensations can be paid with shares or with cash so they effect identically to company’s equity – no matter how the company distributes its profits, with dividend or with share buybacks.

            So whenever there is compensations involved, the investor has to find out whether it is excessive or not. And act accordingly. The end result is not affected by the type of distribution of profits. You can always transform buybacks into dividend cash flow if you want.

            I agree that it is not always easy for the company to reinvest. But instead of dividends the company could spend the money buying it’s own stocks. (Remember, executive compensation is a different matter.) It is up to investor to decide if he want’s the cash or the shares. Or if the share price is good or bad for buybacks. All options are available and identical outcome can be reached – aside from taxes and fees.

            But yes, here the dividends look good, but not as good as in USA. I hope someday we return to the system we had some 10 years ago where dividends were basically tax-free. (Company still had to pay hefty tax for profits. Now we have both taxes.)

            Anyway, thanks for great blog and I hope all is going well in your new home town!

            Q: Do you have any plans entering also Canadian stock market?

            • says

              Paapaa,

              “You can always transform buybacks into dividend cash flow if you want.”

              Cutting down the branches I’m sitting on in exchange for plucking the fruit from the branches is exactly the type of investment strategy I advise to avoid. Again, I think we just fundamentally disagree on the usefulness and purpose of dividends in general.

              And I disagree with you on compensation. I’d advise you look a bit deeper into traditional executive compensation involving stock grants, stock options, shareholder dilution, etc. Again, I just think we disagree on this entire subject, but there’s nothing wrong with that. More than one way to skin a cat, and investing is certainly no different.

              As far as the Canadian stock market, I do already have Canadian holdings. I’m an investor in two Canadian banks – TD and BNS. I’m a happy shareholder thus far. :)

              Cheers!

              • Paapaa says

                “Cutting down the branches I’m sitting on in exchange for plucking the fruit from the branches is exactly the type of investment strategy I advise to avoid.”

                Me too but I’m not sure that is the case here. Consider 2 cases, in one case company pays dividends and in another it does not but does a stock buyback (same amount of money used.) And no executive compensation happening here.

                What happens with dividends? You get the cash, the share price decreases (because company loses cash from its balance sheet) immediately the same amount on ex-date. The total amount (cash + total stock value) is identical – as it should be as no new money is being created. Your invested capital is now less than before dividends and you can reinvest the dividend and increase the number of shares and bring the invested capital back to where it was. (Important to notice that all shareholder value is created by making profit.)

                What about buybacks? When the company buys it stocks, the share price does not decrease (company loses cash but gains shares – a neutral operation). The number or outstanding shares decreases so you just gained more of those branches! This equals to the same situation in dividends where you spend the dividends on buying stock of the same company.

                And this is not any magic. Your portion of the company actually increased. This can be easily shown with actual numbers.

                Now, you can liquidate the “extra-branches” by selling them. Then you would be back to where you were with dividends: some cash and less capital in stocks. And you can choose the amount yourself. So in both cases you have 100% equal options.

                And in all cases there can be executive compensation involved. If company uses shares to pay to executives, then it is taking money from shareholders by dilution. The same happens if they just use cash (as otherwise they could’ve distributed the cash to shareholders as above).

                I’m not sure how much this is a matter of opinion but rather understanding what actually happens in both cases. Again, taxes and fees basically dictates which to prefer.

                I agree completely that excessive compensation sucks. Always. No matter how it is being carried out. Conservative stock option compensation plan might be better than just cash but it depends. And too much is too much.

                But maybe our views have been expressed now. Let’s get back to buying shares :)

                (And sorry for possibly using some incorrect terms as English is not my native language…)

                • says

                  Paapaa,

                  I couldn’t disagree with you more. Trying to equate share buybacks with dividends is something people often try to rationalize, and I just don’t agree.

                  First off, in a perfect world a company’s value would be reduced directly by the same amount as the dividend they pay since the cash is leaving the balance sheet. But we don’t live in a perfect world. As such, I mentioned before that you can’t really point out when a company’s value decreases. Coca-Cola paid out $5 billion in dividends. Where did the $5 billion go in share price? If we lived in a perfect world all assets would be priced appropriately, but the market is an irrational place where fear and greed take center stage.

                  And share buybacks aren’t as efficient as you’re attempting to argue. Tell IBM investors that the buybacks allowed them to sell off more shares while still maintaining the same amount of wealth as if IBM would pay out more dividends. We live in a world where you need cash flow to pay expenses, not ownership percentages of companies. You’re saying the buybacks increase ownership % between remaining owners, and this is true. But if the share price doesn’t go anywhere and you’re busy selling off shares to pay for expenses and you’re one day left with no shares at all, then what do you do? What branch are you sitting on then? Like I said before, I don’t go down to the Net Worth Store to buy stuff. I need cash money, and selling shares will eventually leave you with no shares.

                  I’m not going to argue this point anymore because we’re too far apart on it. But I wish you luck with your strategy!

                  Best regards.

                  • Paapaa says

                    The company’s value always is reduced exactly by dividend amount on ex-div date. This does not mean that there is also a normal share price fluctuation every day. This is easy to see in stocks which pay dividend only once a year. Price goes down on average exactly the same amount as dividend.

                    As for Coca-Cola paying 5 billion, the share price would be higher if KO didn’t pay the dividend. Very simple. But if all KO owners reinvested all the dividends, then there would not be any “dividend dip”. Again, see what happens with companies paying single big dividend.

                    Very good point you can’t sell a fraction of a share, that is very true. But that doesn’t invalid the basic valuation of buybacks and dividends and the basic concept. The the point remains equally valid. It is easier to understand with mutual funds which reinvest all the dividends. It is very easy to show that tax is the only thing that makes a difference if the fund reinvested the dividends or pays it out. And you CAN sell a fraction of a mutual fund “share”. (I don’t know the right terms.) You are not cutting any branches if you don’t sell more capital than the dividend was.

                    For some odd reason many people still insist that dividend is some magical extra money. No. It is the same money the company received as profits and it can be shared in many ways.

                    But I agree that dividends make the cash flow automatic. You don’t have to manually sell anything. That is a good thing, of course.

                    I like dividends, but not because they would make a firm magically more profitable than a company making buybacks.

              • Paapaa says

                I’m just getting to know some Canadian stocks. Have to check out the 2 banks you have also! I believe that diversification is the key so I want to explore new markets too. But with just USA stock market it is quite easy to build a very diversified and good quality portfolio as the companies themselves are very global in US. In Finland we have too few global companies and too much “Finland risk”.

  11. says

    Totally right! Receiving a dividend is comforting and also acts as a security net. It’s an incredible investing strategy. But… One has to be patient… Dividend income doesn’t grow very fast and starting yields are pretty low… The magic of compounding really takes at least 20-30 years to deliver its true amazing magic!

    • says

      Allan,

      Indeed. Compounding takes a while for the exponential curve to take over, and that’s why it’s so important to start as early as possible. I’m glad I started at 28, but I honestly wish I would have started much, much younger. Every day and every dividend counts.

      Better late than never, though. :)

      Stay patient and keep with it!!

      Best regards.

  12. says

    Fantastic and well said Jason!! This is the reason I preferred to invest in Dividend paying companies. Mr. Market moves up and down, but dividends, in most case, go up or stay same. I wouldn’t invest in companies that don’t pay dividend, except Warrant Buffett’s Berkshire Hathaway.

    • says

      Finance Journey,

      You’ve got it. Dividends oscillate MUCH less than stock prices, which makes it easier to focus on them and stay unemotional.

      Yeah, if I was ever to invest in a company that didn’t pay a dividend it would be Berkshire. That would be my only exception, and only because of the immense respect I have for Buffett. I’m a huge admirer, and that would be the one exception to the rule for me. Plus, they have just a great collection of businesses.

      Thanks for stopping by!

      Cheers.

  13. Spoonman says

    This is another fantastic article. After years of searching for a good investment strategy, I eventually fell in love with dividend investing. The way I see it, it’s the only real way to participate in our capitalist system. The whole notion of capital gains just doesn’t appeal to me because half the time it isn’t real wealth, it’s just air–pure speculation. The same can be said of losses, a lot of the time it’s just unfair undervaluation.

    I am also risk averse investor, so dividend growth investing fits the bill really well. Thank you for putting this post together. It’s the sort of post I can hand to anyone that’s curious about DGI.

    • says

      Spoonman,

      You’re preaching to the choir. It’s like you took the thoughts right out of my own head. When I initially became interested in investing I found everything to be scary. You’re relying on these fluctuating prices that seem to go up and down on the whims of robots and emotions. It just seemed extremely speculative and risky. But when I found dividend growth investing I fell in love because the dividends created this buffer between me and the market, while at the same time sending me regular cash money.

      Keep up the great work. Very excited for you guys. The final countdown has begun!

      Best wishes.

  14. says

    Nice article. But I am not sure how you can say that dividends are return on capital and return of capital. I don’t understand how it can be both. In the PM example you mentioned, you can either consider the dividends as extra money on top of the capital appreciation thus increasing your ROI
    OR
    you can consider the dividends as return on capital thus reducing your cost price for PM.

    Another point made by also by paapaa above is perfectly correct. Dividends are not extra money. But it really does help to have recouped some capital in case the market crashes like in 2008.

    • says

      DGJourney,

      Well, let me ask you something: If you invest $10,000 in Company ABC and throughout your ownership tenure Company ABC sends you $10,000 in dividends do you not consider your capital at risk in the markets essentially $0?

      As far as dividends being free money, there’s no free lunch. However, if a company reinvests capital poorly that they otherwise would have sent out in the form of dividends, then in that case dividends are about as close to a free lunch as possible.

      For instance, if you’re on the board of directors for Coca-Cola and you decide to suspend the dividend immediately, where are you going with the $5 billion in cash flow now? How will you grow the business at a rate fast enough to compensate for the additional equity, and still keep the ROE high enough to make that work?

      Best wishes!

      • Someone says

        Well, no, if the company payed me 10,000$ over the years, it would still not cover my initial investment of 10,000$, because of inflation and the time value of moeny. And even after taking that into account, if it did cover inflation, if I had 10,000$ dollars in the company, that’s 10,000$ at risk. It’s as if I had a job that payed me for one month, I wouldn’t have to work for more money because I was already payed, in fact, every month I worked would be one more month of my free time, and in the case of stocks, it world be one more month that my 10,000 wouldn’t be available to me to do as I please.

        • Ravi says

          It’s a question of “exit” risk.

          Everyone has different transaction costs and tax situations and opportunity costs… therefore a different required return.

          Let’s say you want x% return per yr and so in your example, you got back $12k. Whether it “pays you back” and you have no risk, I think the point is that there is value in having the choice to reallocate capital as you see fit.

          In the case of dividends, most brokerages allow you to reinvest dividends for free. Alternatively, you can reallocate and invest in a new company, or you can spend it on a bottle of Coke. :)

          Point is, they provide a choice whereas retained earnings in a company do not.

          The value of that “choice” will vary depending on: a) the company, and b) the investor (tax situation, opportunity cost, desired return, etc).

        • says

          Someone,

          That’s a good point regarding inflation and the time value of money. I was using my example for illustrative purposes, but you took it quite literally.

          However, after factoring for inflation I would at some point consider the capital I have at risk at $0 once all of my capital was returned to me. You disagree with this, and that’s okay. We don’t have to be on the same page.

          Best regards!

      • says

        I am not saying dividends are bad. If I did, I wouldn’t be a dividend investor myself. Coca cola (or other mature) companies typically pay out dividends because there are not enough growth options to invest the entire cash flow.
        Anyway, this is a discussion that is not going to get sorted out here. This is an evergreen point of contention that will be discussed forever :)

  15. says

    Mantra,
    Thanks for the great read and reminders. PM was the first dividend company I purchased after shifting from mutual funds to stocks. Even before I was full committed to dividend companies I liked PM. Looks like you made your first PM purchase the same year I did!

    9/23/2011 PM BOUGHT 12 SHARES OF PM AT $63.5499 ($7.00) $0.00 ($769.60)

    • says

      Jerry,

      Ha! It looks like we were on the same page there in regards to PM. Those were the good ol’ days when a lot of high-quality stocks were pretty cheap. :)

      Thanks for stopping by!

      Best regards.

  16. says

    Great article illustrating how dividends eventually recover all your capital investment although it takes a long time. Any idea what the average length of time is to recover investments this way? Just curious.

    Philip Morris is a tobacco company. Maybe you are a smoker so this doesn’t bother you so much, but if you’re not, I would love to see a post on investment strategy versus values. How it weighs or doesn’t way into your investment decisions. Not being critical, please don’t get me wrong, but I am just very interested in concepts like these. My first reaction is oh I couldn’t buy that stock. But then when I think about it, I realize oh well, if people are stupid enough to smoke, why can’t I profit from it? I think that would be a great post! ;-)

    • Ravi says

      I think we all have our tolerances.

      It’s one thing when it comes to personal choices. It’s someone’s personal choice to drink Coke products, which are sugary and unhealthy and can cause any number of health issues; however, it’s your freedom to do it. By extension, you could suppose that buying KO means you support diabetes, obesity, cancer, and any # of other illnesses.

      In a similar vein, buying PM/MO is also a personal choice. While not the healthiest one, it is legal and anyone’s freedom to do so.

      Now, let’s suppose a situation where a company provided rich dividends and was in the business of ripping off African villages by selling them water at crazy prices. Let’s also suppose it is perfectly legal. Would I support it? Maybe, maybe not. Maybe I’d invest and take their money, and donate to lobby against it. Maybe I’d not invest because I’m against the mission, but I can’t stop others from doing so.

      I think the difference is that as a shareholder you do have a say in what the company does. Shareholders were unhappy with Nike manufacturing some years ago and pushed them for more ethical treatment.

      Today, Wal-Mart workers want higher pay, and if shareholders want that too, they could start pushing the board to act on it.

      You’re not just a lender, sitting back and collecting cash, as you actually own part of the company.

      Great point, though. It would make for a very interesting post!

    • says

      debs,

      Great idea for a post there. I’ve had many people ask me about my values when it comes to investing over the years, so it should probably be written up. To answer your question immediately, I’m not a smoker but I don’t mind investing in tobacco companies. They’re a legal product and adults have the right to use them. I don’t mind profiting from that. Furthermore, if you look hard enough you’ll find something you don’t like about every company out there. Pollution, war, obesity, disease, etc. We don’t live in a utopia because human beings run the planet.

      Best wishes!

      • Dave says

        Great article, and great follow-up discussions, all of them!

        In regards to cigarette/tobacco companies, I once had an aversion to investing in them just like debs above. But now, I’ve seen the e-cig light, so to speak, and I think it is wonderful! I am not a smoker myself, but I think the e-cig idea is the bomb, and I hope many cigarette companies go that route. Unfortunately, it might be a drag for tobacco farmers, but I think e-cigs could be the wave of the future. It makes cigarettes less offensive for non-smokers, and turns cigarettes into the product they were meant to be from the beginning: a nicotine delivery system, without the offensive and health deteriorating chemicals and addictions.

        • says

          Dave,

          E-cigs are growing quickly, and I’ve heard predictions that say they’ll overtake traditional cigarettes in the next decade. We’ll see, but I think this is a lifeline for the tobacco industry in that it’s faced secular decline for many years now. This is actually an exciting growth category, and it’s much less offensive. So the gray clouds around Big Tobacco are clearing a bit here, but there’s also still a lot of questions surrounding future regulation here. These products are still in their relative infancy, but it’s exciting!

          Cheers.

  17. Ken says

    Have to agree with some of the comments above regarding:

    1) Dividends can not be a return on capital as well as a return of capital (stock prices decline by the amount of the dividend on the ex-div date)

    2) Dividend paying companies are returning capital as they see fit, versus selling shares as the shareholder sees fit. You are trusting management versus yourself. That’s fine. Let’s be honest, those guys are probably smarter than us.

    Jason, you mention the example of Coca-Cola suspending its dividend and question the company’s ability then to maintain its growth rate, etc. Successful, growth-oriented companies typically end up paying a dividend because of those issues. You don’t need to look any farther than tech giants of years past to see it. Coca-Cola in its current state would never do this. But if the company decides to enter into new businesses or massively expand its product line and as a result had to cut its dividend for a time, would you sell simply because the dividend no longer exists?

    ——–

    Dividend growth investing works but only because successful dividend growth investors are buying VALUE and STABILITY. There are plenty of “dividend growth” investors who’ve flamed out because they limit their analysis to the dividend payout. Same applies to pure growth investors.

    Dividend growth investing may or may not provide a smoother ride than buying a total stock market index fund in the future, but it won’t do so because the companies pay dividends, Well valued dividend paying companies usually have low beta stocks. Low beta smooths an equity curve and dividend payouts are just a by-product of choosing those companies.

    I’d also argue that dividend growth investors do themselves a favor by inherently limiting the number of companies they can analyze before buying. They become good at their niche. But rest assured, there are plenty of pure growth investors out there doing the same with as much, more, or less success ;)

    Good luck!

    • says

      Ken,

      As I understand it, the stock exchange manually adjusts a stock price to reflect a dividend paid. However, that doesn’t mean this actually affects the ultimate price of equity investors are willing to pay. Look at a long-term chart of any company that pays out dividends and I dare you to point out the days dividends were paid out by looking only at the chart. There’s no possible way to know what would have ultimately happened to a stock had the dividend never been paid. We’d have to have an alternate universe around where KO never paid a dividend to see how the share price would have performed. But, as I mention and you agreed with, the dividend is paid out because management is admitting shareholders can/should do better with the capital.

      As far as what I would do if a dividend is eliminated, I would generally sell. This isn’t a guess on the long-term success of a company, but rather me sticking to my strategy. I’m hoping to one day pay for all of my expenses via dividend income. If a company isn’t paying dividends then it isn’t really fulfilling its end of the bargain. I can’t pay bills with future promises of a reinstated dividend. Now, I won’t always sell. If I feel a company has a great shot at paying the dividend again in the very near future I might make an exception. However, for the most part a completely eliminated dividend would usually force me to go elsewhere with that capital. Not to mention a dividend cut is likely going to cause the share price to decline significantly, compounding the problem.

      Value and stability is important, but so is growth. Any successful investor, focused on dividends or not, should be looking at a company’s viability and ability to grow in the future. Growing dividends are funded from growing profits. If a company isn’t growing its profits and has no clear plan to grow them in the future then I’m probably not interested.

      Thanks for stopping by!

      Best regards.

  18. Spencer says

    Jason,

    I am a huge supporter of your journey, thank you for being willing to document it in such a way that those of us who are interested can benefit from it. I agree with you 95+% of the time, as my investing philosophy is similar. My portfolio is full of dividend champions, and unless a more sound process comes along for generating wealth, I will stick to it (one that doesn’t require me to spend hours a day doing something I don’t want to, like being a landlord haha).

    I need to say quickly that I try to NEVER be that guy that comments on a post with negative comments just for the sake of arguing, or trying to pick a fight. I am a tax account and actually work for a private equity firm that buys real estate, so I have a pretty good understanding of cost basis and also both the literal and economic differences between returning a dividend to shareholders vs. buying back shares. I am not at all trying to poke the dead horse that has been beaten to death on Seeking Alpha about this topic.

    Towards the end you said “See, no matter what happens to Philip Morris from here the capital I have at risk right now is only $7,067.30, and that’s because Philip Morris has sent me checks that total up $860.25. It doesn’t matter what Mr. Market might think of the company and its future prospects, the business itself has sent me capital. Eventually, if I hold the position long enough and they continue paying dividends, Philip Morris will send me so many dividend checks that they will add up to more than I initially invested in the company. At that point, my capital on the line is essentially $0.”

    My only thought I could have while reading this was that I agree with you in the sense that this is probably the best way to approach dividend stock investing in general, only because you are pretty sure deep down that the company isn’t going to go bankrupt. But acting like the 10k that you own of the stock isn’t at risk because you already got your initial investment back can only be done if you are completely ignoring the opportunity cost of that 10k. The reality is that you COULD sell it and invest in something else if you wanted (please note that I am not saying this is always, or even sometimes, the best option). I am simply saying that opportunity cost should always be considered when deciding whether or not to leave an invest alone or do something else with the money. I don’t know exactly how much Berkshire has received in dividends from its purchase of Coke, but I imagine it has either already crossed either initial cost basis or will soon if it hasn’t. But even after it does, I cant imagine that Buffett would look at the 14B or whatever their position is worth and think, “eh, we got our initial money back, so now this 14B is house money to gamble with”.

    Anyway, that was too long of a post. Keep up the good work, I love what you do. I wish you the best of luck.

    Spencer

    • says

      Spencer,

      Thanks so much for the comment. And no problem not being on the same page as me. Sometimes the concepts I put out there are more for “getting you to think” than to actually use on an everyday basis. And some people at SA thought this article (it was republished there) was meant as a literal dissection on tax law, which couldn’t be further from the truth. Sometimes people take my articles for literal, legal definitions. I suppose I just assumed investors are smart enough to know the difference between a general discussion on a benefit less talked about (capital at risk reduced) vs. a discussion on tax laws.

      But I agree with you on opportunity costs. Obviously, I would be very disappointed if any of my investments went bankrupt. And even if that business sent me all of my initial investment capital back in the form of dividends, I’m losing any gains and a future stream of cash flow from that investment. Furthermore, there is inflation, the time value of money, and the opportunity costs of going elsewhere with that capital that could have had better results. So, yes, I was using a company that is highly unlikely to go bankrupt (although with litigation you never know) to illustrate my concept.

      And I don’t literally reduce my cost basis when a dividend hits. You’ll note the cost basis in my portfolio matches with the exact legal cost basis, as you can see with PM very clearly. This was more of a concept article, or an abstract idea on how your capital at risk can be reduced via dividends. I didn’t mean to say your legal cost basis is reduced with dividends.

      I hope that clears up my thoughts on this, but let me know if it doesn’t.

      Best wishes!

  19. Ravi says

    Well, just initiated a position in WFM for 48 shares. My 2-yr outlook on the shares is positive. Good news on TGT as well. I wish I could have gotten both, as I think both are undervalued on a short-medium term, but thought WFM offered greater potential.

    In a downturn, I think WFM would hold up better as it serves a more affluent consumer.

    We shall see…

    • says

      Ravi,

      Great job there. I think WFM has a lot of potential not only as a business, but also as a dividend growth stock. And I think you’re right in that it should be able to withstand major economic downturns since its customer base is relatively affluent, or at least is willing to pay a premium for food products. Maybe I should take another look at it. I still remain a bit concerned with competition in traditional forms like Trader Joe’s, but also bigger players potentially entering this space and encroaching on WFM. However, they’ve got a very unique experience there and I suspect a loyal customer base.

      And TGT definitely surprised today with that big divi boost. Good stuff from the retailers in spite of all the noise. That’s why I ignore the noise. :)

      Best wishes!

      • Ron says

        I’d love to buy WFM if it started to build its new stores in a much smaller format like TFM and Trader Joes. I believe e-commerce will be eating everyones lunch (WMT, TGT). In a few decades most people will be ordering non-perishable goods online and buying milk/eggs/produce/etc at the stores. I think WMT/TGT/BBY/WFM and all other big retailers will need to adapt quickly. You can already see what happened to BBY. Take a look at what’s happening with Walmart.

        “Walmart’s smaller stores, Neighborhood Market, Walmart Express and Walmart to Go, were another bright spot during the first quarter. Neighborhood Market comparable sales jumped 5 percent and traffic rose 4 percent. April marked the 46th straight month of same-store sales growth for the concept. The company is now accelerating the opening of these small-format stores which attract more shoppers making quick, midweek grocery trips. Walmart will build 270 to 300 small stores in the next 12 months, doubling its initial forecast of 120 to 150.”

        Read more: Walmart profit drops 5% as small-format stores, Web sales grow – FierceRetail http://www.fierceretail.com/story/walmart-profit-drops-5-small-format-stores-web-sales-grow/2014-05-15#ixzz34NJxxzRJ
        Subscribe at FierceRetail

        • says

          Ron,

          I agree with WMT’s more aggressive stance in regards to the smaller format stores. I think their future growth lies there.

          However, I don’t think e-commerce is going to eat all of WMT’s lunch, as they’re enjoying healthy growth in that arena themselves. Same goes for some other retailers, though TGT has to pick up the pace there.

          Cheers!

    • says

      Schmuel,

      I had CNBC on as background noise earlier today when my ears all of the sudden perked up as they announced this raise. What a whopper!

      I’m surprised by the size of the raise, but certainly glad. I was expecting something about half that level, to be honest. I think they still have concerns in Canada, though they’re improving there. And total costs regarding the breach is still unknown. In addition, management changes leave some questions.

      However, earnings will eventually normalize and then we’re looking at a very attractive investment. In the meanwhile, TGT is taking shareholders seriously here and rewarding them for loyalty. It’s much appreciated.

      Best regards.

  20. says

    Fantastic post DM, I always love to see someone take a unique, fresh perspective on these things, and really liked the way you expressed this.

    It’s obviously generated some great technical discussion, but I agree with the more ‘practical’ points you highlight. The downfall of most investors is irrational buying and selling behaviour, and receiving portions of your money back over time, without you having to try and sell portions at various points in time as the market moves about wildly, is a great way of approaching things.

    I think these sorts of perspectives can really help make people better investors, rather than getting too far into all the technical debate. Thanks again for another great post.

    Cheers,

    Jason

    • says

      Jason,

      Thanks for stopping by!

      I think you nailed it there. I’m only here to help investors stay in the game and become successful over the long haul. Getting bogged down in technicalities sometimes bothers me because it’s missing the forest for the trees, in my opinion. I simply try to conceptualize certain investing aspects and then present them in plain language. I’m really just here to inspire, but I can also understand how some people take offense with my articles sometimes that wander away from core investing facts. However, I stick by my writing and my opinion. As you mention, the mindset I presented in the article can help one from getting trapped by irrational behavior.

      Thanks for adding that. I really appreciate it!

      Take care.

  21. KeithX says

    Wow, interesting discussion. Owning stock is the same as buying a business, the only difference is that you only own a piece and not the entire entity. Would I buy a business if it didn’t return any capital to me, but just gained in value over time? Absolutely not. So, dividends make a lot of sense to me. But I will admit that I have a very small number of stocks in my portfolio that don’t pay dividends. I just prefer to have the businesses I own put money in the bank.

    • says

      KeithX,

      Couldn’t agree more. It’s all about the cash flow, baby.

      It would be no different from buying a local restaurant. To own this business and only count on appreciation would be ludicrous, in my opinion. So if you need cash you sell pieces of your restaurant until you don’t own it any more?

      Ultimately, every business is simply worth the amount of cash flow it can provide its owners from now until eternity, discounted back to a present rate. To then “take a pass” on some of this cash flow makes no sense to me.

      And it’s funny how people always cite Berkshire Hathaway in these dividends vs. capital gains arguments (an argument I hate, by the way), yet Buffett has not been shy about his enthusiasm for collecting dividend income from his stock holdings and profits from his private businesses. Funny how that works.

      Best wishes!

  22. says

    Another thing I like about dividend paying companies is that they are not investing their profit willy nilly. They have to return part of the profit to the investors. I don’t trust the companies to invest wisely anymore after working at a big hi tech company. When they have a lot of money, they invest pretty stupidly…

    • says

      Joe,

      Couldn’t agree more. Knowing that a good part of the cash the company generates is earmarked for shareholders means management has to be that much more prudent with whatever capital is left. Absent that, management can do whatever they want with that cash, and that just encourages bad investments or empire building. In the end, dividends force sensibility and thoughtfulness with available cash.

      Great point. Appreciate you stopping by!

      Cheers.

    • says

      Jose,

      CAT’s dividend increase was mighty impressive. DE also had a very nice increase recently, so both of those companies are rewarding shareholders very nicely right now.

      And although it’s in a different sector, TGT also had a blockbuster raise. I can only say I never, ever received yearly increases from my day job like I receive from high-quality companies. This is why I’m slowly moving from the working class to the investor class. :)

      Cheers!

      • Justin says

        What’s your take on DE? I’ve been watching it forever, but I’m not especially good at analyzing very cyclical companies, so I can’t pin down a fair value.

        • says

          Justin,

          Good question there. DE is interesting. The fundamentals appear okay to me, and the recent dividend increase was extremely impressive.

          But DE’s earnings are expected to fall over the next couple of years, which will either cause a P/E ratio expansion or a fall in the share price, or some combination of the two. I personally tend to shy away from cyclical companies because I prefer more secular plays where earnings growth and dividend growth is pretty steady. However, that doesn’t make DE a bad investment here for the long haul as the next 2-3 years matters little against the next 2-3 decades. Furthermore, I passed on CAT around $80 or so per share last summer and that stock has been on a hell of a run since then. So I’m not always good at timing/analyzing these cyclical stocks either.

          Overall, I’m mixed on DE. I think the long-term prospects are probably pretty bright, but the short term appears cloudy. Deere has been forecasting falling commodity prices, which will ultimately affect demand for their products. But you have to imagine that the next 2-3 decades look good as more people will require more food to feed them, and agriculture should remain a strong industry due to this. Of course, some kind of technology could revolutionize this and kill demand. I’ve read some pretty crazy stories on food engineering and growing food in a lab, which would overturn the traditional agriculture industry.

          Cheers!

  23. says

    Great post. The return on capital is what sold me to start dividend growth investing. In good times and bad, you are getting a portion of your capital returned to you each disbursement. Capital gains are just icing on the cake!

    • says

      FI Fighter,

      I’m with you, my friend. Capital gains are just the icing on the cake. And many of us will never even need the capital gains as we’ll be living solely off the income these investments provide. That means the icing just continues to get sweeter over time. Mmm, sugar. :)

      Take care.

  24. Phil says

    I’m new to your site, and I’m glad I found it! I’m a huge proponent of dividends; yield and P/E ratio are two of the main elements of a stock I check before purchasing. My dad’s been investing in stocks that pay dividends for 40+ years, and he’s done very well for himself.

    Like you said, what’s great about dividend stocks is that you win on both fronts. You get dividends AND the stock can go up. And when the stock price dips, your dividend reinvestment goes further. I also like dividends because they help cushion the blow if one of your stocks falters. I bought Exelon (EXC) at $40 a few years ago. It then sank down to $28. Whomp whomp. But thanks to dividend reinvestment, my total dollar loss wasn’t so severe. Instead of losing 25% of my initial investment, I was only down 15-20% or so. I kept reinvesting the dividends, getting shares at this cheap price. Now that the stock is up to $36, I’m back in the black. Of course, I wish Exelon had done better, but who knows? Maybe it will have a dramatic rebound next year or in 5 years, making my investment even more valuable.

    I look forward to reading more about your dividend journey!

    • says

      Phil,

      Thanks for stopping by! I’m also glad you found the site. :)

      Sorry to hear about your experience with EXC, but those sizable dividends have turned a loss into a small gain, and that’s fantastic.

      I look at every stock investment as a gamble, and dividends are a hedge. Maybe the company doesn’t perform as expected, but the dividends hedge my bet and pay me to see how the bet turns out. A win-win. :)

      Stay in touch!

      Take care.

  25. says

    Hi DM,

    I’m with you. I know that a dividend is a return of capital and that on the day of the dividend payment the stock price is reduced by that amount. Yet I think that the price reduction gets lost in the noise of daily trading fluctuations since it’s a small percentage and daily market trading typically drives higher price variation.

    I think dividends do add an emotional element to the stock price however. If tomorrow, the board of ADP who have increased dividend payments over the last 39 years, announced they were stopping their dividend payment because they wanted to hoard cash (i.e. not because they couldn’t afford to pay it), I’m sure the stock price would still go south fast because a lot of investors would sell on hearing the news. This would likely happen, without any change in the fundamentals of the business. Conversely because the company has paid dividends so reliably for such a long time, perhaps the stock price is higher than it might otherwise be?

    So I guess at the end of the day, I look at a dividend as a return of capital that I can choose to invest back into the company if I want to. That is more preferable to me than watching the number of stocks I own slowly decline as I sell 4% of them each year.

    • says

      Dividend Life,

      Well, I can understand the detractors to dividends and the usefulness of them.

      However, the points are all based in theory. We’d really have to have a Coca-Cola in an alternate universe that never paid dividends to shareholders and see how they did. Or maybe even 1,000 Coca-Colas in alternate universes where they all did something different with the cash. However, as I pointed out, I don’t invest in coulda, shoulda, wouldas. I invest in cash flow because it’s cash flow that will one day pay my expenses.

      Trying to play the game via share buybacks and *hoping* Mr. Market recognizes the value means you may be left high and dry in a bear market as you have to sell shares that are steadily declining in value to pay for your lifestyle. That is a situation I’ll just never find myself in.

      There are many benefits to dividends, and I try to cover a unique aspect with these types of articles. Invested capital returned to you to do with as you please while you are technically reducing your capital at risk is just but one of many wonderful benefits.

      Thanks for stopping by!

      Best wishes.

  26. says

    Great point of view Jason. I’ll add that using some form of dividend reinvestment plan (either back into the same stock or another stock), the potential return is even greater. Simply put, dividends definitely lower ones risk. Our family has been turned onto dividend stocks investing for about a year now and can’t imagine life without them.

    To more and growing dividends…Cheers! AFFJ

    • says

      AFFJ,

      I’m with you all the way. Although I don’t always reinvest dividends back into the same company that paid them, all the thousands of dollars in dividend income I’ve received over my investment lifetime has been used to purchase stock. It’s wonderful to know that as the snowball grows it picks up fresh snow all by itself. :)

      To our continued success!

      Take care.

  27. says

    DM – I like it, very interesting way to break it down in terms of return OF capital – never perceived it truthfully in that light. I only look at the cost basis and say – how many years would it take in dividends to receive that cost back, so I do it in the Macro-level for lack of better words on the return of capital. It’s amazingly interesting how your ROI is impacted by dividends. Every dividend/investor should review this to see the numbers-based proof that dividend income investing extrapolates your return potential.

    Also – hopefully the readers saw that you purchased PM at many different prices – some may think – oh wow, DM overpaid for the stock during BLANK purchase as it was $20 higher than his earlier purchase. But really -the valuations change over time, as earnings/financial statement composition change, to where as the higher priced you paid later on, could have been more undervalued than the first purchase. I like it and dig it. Have a great weekend! We’ll have some articles to pump out as well. Keep at it.

    -Lanny

    • says

      Lanny,

      I also like to look at it from your point of view. If I invest $1,000 in ABC Company, how long would it be before I see all of my $1,000 back just from dividends? Once all of your capital is returned to you your risk has essentially been removed.

      And that’s a great point there in regards to price vs. value. Price has nothing to do with value. Paying $100 for shares in a company means nothing if you have no idea of what those shares are worth. And paying more and more for stock in a company over time is generally a good thing, assuming that the underlying profits are rising in kind.

      Looking forward to some new articles over there at DD. :)

      Thanks for stopping by!

      Best wishes.

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