Make Dividends Your Servant

Way back in 1900, William Jennings Bryan uttered the words "man is the master, money the servant."

The words were part of a major speech railing against imperialism and had next to nothing to do with investing. Yet, rereading the speech, those words jumped out at me. After all, he's dead on -- money should be our servant, not the other way around.

So how do we make money our servant? "Investing" is the obvious answer, but there are a great many ways to invest and many of them require a great deal of effort on your part. And if you're burning the midnight oil to do your investing, then it hardly sounds like your money is your servant.

But what about investing in large, well-known dividend stocks and hanging onto them for long periods of time? I'm talking about companies that you're likely already very familiar with and that you'd feel comfortable letting sit in your portfolio for years, if not decades. Now that sounds a lot more like a servant to me.

But could such a radical approach possibly work?

Let's take a look
To test this out, I took a look at all of the companies worth $10 billion or more at the beginning of 2000. I then took this group and split it between the 174 dividend payers and the 75 non-dividend payers.

And how did the two groups fare over the past decade? In terms of just about every growth metric, the non-dividend payers blew their foes out of the water. The former group posted an average 11.2% annual revenue growth rate and an average 9% annual earnings-per-share growth rate versus 4.8% and 6.9% for the dividend payers.

But in the end that didn't matter. Despite the better growth rates, the non-dividend payers posted an average 7.7% stock price decline over the timeframe, while the dividend payers gained an average of 9.5%. Quite a difference. And bear in mind that these numbers are not adjusted for dividends. (I'll get to that later.)

To make it even more interesting, I then cut it up so that the dividend-paying group contained only stocks with a "meaningful" dividend -- in my mind that means at least a 1% yield -- and the second group contained everyone else. This time the disparity was even more noticeable. The stocks with a meaningful dividend yield saw their prices rise an average of 29%, while the other group fell an average of 15%. And again, these price changes were not adjusted for dividends.

Skeptical of my own results, I reran the experiment using the bull market stretch between October 2002 and October 2007. Surely the non-dividend payers and their superior growth would win this time, right? Wrong. The companies with a 1%-or-better dividend yield came out on top again, this time 111% to 67%.

But why?
I chalk up the difference to the power of dividends. These regular payouts tend to say a lot about a company. For instance, they typically say that the company is actually earning real cash, that the company's management thinks sharing the wealth with shareholders is important, and that the company is stable enough to promise regular cash payouts.

Furthermore, when we look at the dividend yield, we can also get at least somewhat of an idea of whether the stock is reasonably valued. For instance, at the beginning of 2000, the group with a meaningful dividend yield had an average price-to-earnings ratio of 32, while the other group's average P/E was a significantly higher 69. Sure, there are many other factors to look at when performing a valuation analysis, but this is certainly a good indicator.

In other words, dividends tell you that you've got a company that's actually working as your servant; it's likely a quality servant and you're likely paying a reasonable price for its services.

It gets even better
As I noted a few times above, the returns I used to compare dividend payers to non-dividend payers weren't even adjusted for dividends. But we certainly don't want to ignore the impact of the dividends. After all, the regular cash payouts are a big part of the reason that we're hiring these servants in the first place.

When you do make that adjustment, the results can be pretty amazing. Check out the 10-year performance of these dividend payers:

Company

Dividend Yield
in 2000

10-Year Price Change

10-Year
Dividend-Adjusted Price Change

Burlington Northern Santa Fe

2.0%

309%

383%

General Dynamics (NYSE: GD  )

1.8%

168%

219%

Caterpillar

2.7%

156%

234%

ConocoPhillips

2.9%

126%

195%

Altria (NYSE: MO  )

8.0%

(11%)

557%

Source: Capital IQ (a Standard & Poor's Company) and Yahoo! Finance.

My findings here really punctuate research from Jeremy Siegel and others: The greatest long-term winners come from the ranks of dividend payers.

Investors, meet your servants
For investors looking for dividend-paying servants, the recent financial crisis and market crash has been a great boon. The slate of servants for hire with a meaningful dividend yield has expanded significantly, which gives investors a heck of a lot more high-quality companies to choose from. Here are just a few:

Company

Current Dividend Yield

Wal-Mart (NYSE: WMT  )

2.0%

Johnson & Johnson (NYSE: JNJ  )

3.1%

Chevron (NYSE: CVX  )

3.8%

PepsiCo (NYSE: PEP  )

3.0%

McDonald's (NYSE: MCD  )

3.5%

Source: Yahoo! Finance.

Of course with a huge number of companies currently paying juicy dividends, it can take some up-front work to decide which dividend-paying servants you want working for you. While many investors may want to tackle this on their own, a helping hand can often be beneficial in picking out the best opportunities while skipping over the stinkers.

The folks at Motley Fool Income Investor focus solely on dividend-paying stocks -- that is, the stocks that work for you -- and by picking some of the top dividend payers of the bunch, they've managed to handily outperform the rest of the market. If you want to check out their best ideas, you can take a free 30-day trial.

General Dynamics and Wal-Mart Stores are Motley Fool Inside Value recommendations. Johnson & Johnson and PepsiCo are Motley Fool Income Investor recommendations. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Matt Koppenheffer owns shares of McDonald's and Johnson & Johnson, but does not own shares of any of the other companies mentioned. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants ...


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