I took my first investing class as a teenager, and one moment stands out in my memory. A fellow student asked the instructor, a stockbroker, about dividends.
"Dividends?" he asked. "I'm trying to make my clients wealthy. You don't do that waiting for tiny checks in the mailbox every quarter."
Even then, I had enough horse sense to know he was wrong. Paying attention to dividends is exactly how you become wealthy over time.
Wharton professor Jeremy Siegel made a wonderful discovery in his book The Future for Investors. The greatest long-term returns typically don't come from the most innovative companies, or even companies with the highest earnings growth. They come from companies that happen to crank out dividends year after year. Simply put, since the 1950s, "the portfolios with higher dividend yields offered investors higher returns."
Market commentary regularly centers around price gyrations, yet dividends have historically accounted for more than half of total returns.
Reinvest those dividends, and the results are even greater. Take, for example, Coca-Cola (NYSE: KO ) . Since the late 1960s, Coke's shares have increased 4,800%. But add in reinvested dividends, and the total return jumps to over 15,000%:
Source: Capital IQ, a division of Standard & Poor's
There's no ambiguity here: Over time, Coke's share appreciation alone has paled in importance to the power of its reinvested dividends. The results are similar for competitor Pepsi (NYSE: PEP ) , whose reinvested dividends skew total long-term returns overwhelmingly higher. If you're a shareholder, don't worry about daily -- or even yearly -- share wobbles. Devote your attention those dividend payouts, and your commitment to reinvest them.
And how do Coke's dividends look? The company has paid a dividend every year since 1920. Its current yield -- 2.8% -- isn't terribly high, but still decent by today's standards. Over the past five years, Coke's dividends have used up 60% of its free cash flow, which indicates its dividend is well covered and likely safe from any immediate cuts.
To earn the greatest returns, get your priorities straight. What the market does is less important than what your company earns. What your company earns is less important than how much it pays out in dividends. And what it pays out in dividends is less important than whether you reinvest those dividends.
Add Coke to My Watchlist.