The Mind-Boggling Power of Dividends

I'm no stranger to dividends. I appreciate their value, and have written about them on many occasions. I've explained how my dividends are bigger than yours, and how even Warren Buffett is a dividend aficionado. I recently ran across some data, though, that made me sit up and take notice. Let me share it with you.

In a 2003 Financial Analysts Journal article, editor Robert D. Arnott, drawing on long-term stock market data from G. William Schwert and Jeremy Siegel, found that between 1802 and 2002, a $100 investment in the stock market would have grown to $459 million. (This assumes no taxes and no fees.) On an annualized basis, that averages out to 7.9%.

Here's where it gets fascinating -- Arnott calculated that 5 percentage points of that 7.9% came from dividends, a figure that easily dwarfs the contribution from stock appreciation, dividend growth, and inflation effects.

That's pretty amazing. I'm used to the frequently cited average annual return for the stock market of around 10% over the past century or so -- but we often don't bother to think about what makes up that 10%. To get to a "real" return, you'd have to strip out inflation, which would reduce the return somewhat. But it seems that if you took out dividends, you'd reduce that return by much more.

But wait ...
Sure, a skeptic might note, not unreasonably, that today's world is much different from the world of, say, 1850. And others might point out that when we use S&P 500 data to represent the market, which the above study did for part of the period, we forget that many companies have been dropped from the S&P 500 over the years, and the (probably negative) effects they would have had on it have thus been washed out. True again. (This is called "survivorship bias.")

But the power of dividends isn't only evident over 200 years. As Shannon Zimmerman explained in "The Secret of Dividends," "Between January 1926 and December 2006, 41% of the S&P 500's total return was due not to the price appreciation of the stocks in the index, but to the dividends its companies paid out." And as Mathew Emmert once explained in another article:

The S&P 500 index jumped from about 100 points to 1,250 points -- more than a 1,000% increase -- from 1980 through 2005. That's a hefty bull market. And during that time, dividend payers outperformed non-payers by more than 2.6 percentage points per year.

It's powerful
So that 5-percentage-point chunk isn't so easily ignored or explained away. It suggests to me that I might be better off adding more dividend payers to my portfolio. And here's some good news -- it's a darn promising time to do so. With the market having swooned so in 2008, lots of good companies are beaten down, and thus their dividend yields have risen.

Check out these, for example:

Company	Current Yield	1/1/08 Yield
Abercrombie & Fitch (NYSE: ANF  )	2.6%	0.9%
Johnson & Johnson (NYSE: JNJ  )	2.5%	2.5%
DuPont (NYSE: DD  )	5.9%	3.5%
Intel (Nasdaq: INTC  )	3.6%	1.7%
Bristol-Myers Squibb (NYSE: BMY  )	6.2%	4.4%
Automatic Data Processing (NYSE: ADP  )	3.3%	2.3%
Home Depot (NYSE: HD  )	3.5%	3.3%

And remember that those yields are just the beginning of the story. Dividends of healthy, growing companies tend to be increased over time. Automatic Data Processing pays out a quarterly $0.33 per share right now, but 20 years ago it was paying $0.01875. That's a 15.4% compound average annual boost! Johnson & Johnson is paying $0.46 per share per quarter right now, but 20 years ago it was $0.03625, representing an average annual increase of 13.5%. That's how dividends turbo-charge a portfolio -- by growing over time. Keep them reinvested in more shares of stock and they can make you rich.

If your portfolio isn't laden with at least a handful of dividend payers, consider adding some. We'd love to introduce you to many promising dividend payers through our Income Investor service, which you can try for free. On average, its picks are beating the market handily and offered an average current yield of 5.6%. Click here to learn more.

Longtime Fool contributor Selena Maranjian owns shares of Johnson & Johnson and The Home Depot. Johnson & Johnson is a Motley Fool Income Investor pick. Intel and The Home Depot are Motley Fool Inside Value selections. The Fool owns shares of Intel. Try our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.