Growing Wealth By Watching Paint Dry: The Power Of Dividend Investing

"Do you know the only thing that gives me pleasure? It's to see my dividends coming in."

- John D. Rockefeller

While Warren Buffet, Jeff Bezos, and Bill Gates are extremely wealthy, they aren’t close to being the richest American of all time. This title belongs to John D. Rockefeller, the founder and leader of the Standard Oil Company. If Rockefeller’s worth was calculated today, he would be worth over three times more than Warren Buffet.

Rockefeller didn’t attain his wealth through captivating, high-tech ventures like electric vehicles and private space travel. How did Rockefeller gain so much wealth?  Aside from controlling a massive oil monopoly, he held on to his stock and collected the generous dividends that it paid. Although a sloth-like dividend clipping approach is akin to watching paint dry, it remains a key tool for growing wealth longer term.

The Unsung Hero Of Stock Market Returns

Dividends have made up a substantial part of the stock market’s total return, but they rarely get the headlines.  In fact, from 1970 to 2020, over 75% of the S&P 500’s return was from dividends. As the chart below illustrates, during this period spanning a half century, dividend payments and reinvestment were the key wealth drivers of the stock market.

                                                               Source: JP Morgan Asset Management

This investment style may get lost in today’s stock market frenzy of SPACs, meme stocks, electric vehicle IPOs etc, however it remains a time-tested tool for wealth creation over time.

What’s In Your Payout?

The great tool to measure whether a company will be able to pay a consistent and possibly increasing dividend is through the payout ratio. The ratio is calculated by dividing a company’s annual dividend per share by the earnings per share. For example, if a company pays a dividend per share of $0.50 and generates earnings per share of $1.00, the payout ratio is 50%.

A high payout ratio means that a company is using a significant amount of its earnings (and cash) to fund the dividend, which leaves them with less money to invest in future growth of the business, which rarely bodes well for shareholders. Remember as a shareholder, the company’s growth is your growth.

Follow The Dividend Gains & Avoid The Dividend Pains

Knowing how to calculate this ratio can spare an investor from the anguish of a sudden and sharp reduction in income and stock price. With corporate earnings hitting all-time highs, a dividend cut is a lot more surprising and financially painful now than it was just over a year ago.

Take the case of two established industrial conglomerate stocks, General Electric and Honeywell. Over the years, due to business strategy issues, excessive debt, mismanagement etc., General Electric stressed its dividend payout excessively and the dividend suffered a death by multiple cuts, Meanwhile, Honeywell’s dividend keeps on trucking higher:

This dividend path bifurcation has directly translated into both massive stock market value creation and destruction over the longer term. 

                                Source: Koyfin

How To Dividend Invest Like A Rockefeller

There are several key principles to apply with dividend investing that can ensure better investment outcomes.

First, insulate yourself from people’s opinions about dividend investing.  Many investors today are fixated on making big money shorter-term from investments oftentimes with unproven business models. The disciplined and confident investor will have the patience and intestinal fortitude to stick with the proven process of waiting and collecting growing dividends over time.

Second, reliable and growing dividends come from companies with predictable revenue streams. Yes, GE once operated a more simple and predictable businesses. However, it ultimately chose a path of “diworsification” into long-term care insurance and oil and gas, which led to painful dividend cuts and shareholder value destruction.

Third, reinvesting dividends to unleash the power of compounding can outperform many other forms of investing. This watching-paint-dry approach, especially during times of higher inflation and interest rate increases has performed well as show below. 

                                   Inflating Dividends and Interest Rates: A Good Combo After Rate Increase

Conclusion

“You only find out who is swimming naked when the tide goes out.”– Warren Buffett 

While dividend investing is a timeless strategy, it can get lost in today’s frenetic stock market smorgasbord of SPACs, meme stocks, EV brouhaha etc. These market regimes come and go and dividend payouts can change on short notice. However, applying the tried-and-true principles of understanding dividend payouts and reinvesting growing dividends can be a key tool to growing wealth longer term.