If you're like me, losing money hurts. For a while, I even had myself believing there was no way I could in the market. When I took a flyer on TiVo
In 2003, when TiVo rocketed to more than $13, I was declaring myself a genius and picking out my Mercedes. Then TiVo started falling. and falling. and rising!... and falling. It now trades below $6.
Today, I continue to ride my bike to work, and I sold my shares of TiVo for a loss. If I wanted to get closer to a Mercedes, I should have bought DaimlerChrysler
But that's part of the game, right? Buying risky stocks such as TiVo is what leads to world-beating returns.
Not quite. Mathew Emmert writes the Motley Fool Income Investor newsletter to show that it doesn't have to be that way. By finding strong companies that generate cash, reward investors, and are managed well, Mathew takes the sting out of the market and beats it just the same.
Stocks as bonds
Bonds are less risky than stocks because bondholders are assured a rate of return (coupon rate), a payment schedule, and a date to maturity. In the event that a company goes out of business, bondholders also get paid before equity holders. Unfortunately, bonds have a ceiling. No matter how well a company performs, bondholders get nothing more than the coupon rate they agreed to.
The solution: see stocks as a kind of bond. Warren Buffett does. A company that pays a reliable dividend is a "stock/bond." As such, it assures shareholders a minimum yield (rate of return) and the opportunity to realize capital gains. Take, for example, Income Investor recommendation Diageo
In the past year, Diageo paid $2.09 per share in dividends. If you purchased Diageo in April 2004 at Mathew's recommended price of $53.34, you realized a 4% return on the dividend yield. Sound small? The S&P 500 is up only 1.4% since then. In other words, your Income Investor-recommended investment in stock/bond Diageo could have helped you beat the market without having to sell your shares. That means not having to pay your broker and not having to reduce your stake for the long term. Plus, like a good bond, Diageo always pays.
| 2000 | 2001 | 2002 | 2003 | 2004 | 2005* | |
|---|---|---|---|---|---|---|
| DEO Dividend | $1.56 | $1.65 | $1.76 | $1.90 | $2.04 | $2.10 |
| DEO Yield | 4.1% | 3.6% | 3.9% | 3.9% | 3.7% | 3.6% |
| S&P 500 Return | -10.1% | -10.5% | -23.8% | 22.3% | 9.3% | -4.9% |
As you can see, Diageo's dividend has increased in each of the past five years, and its yield alone beat the S&P in four out of those five (and is expected to do so again this year!).
I hear you grumbling because the yield never gets above 5%. Remember, that's only the dividend yield. Because stock/bonds are the best of both worlds, there were also capital gains.
| 2000 | 2001 | 2002 | 2003 | 2004 | 2005* | |
|---|---|---|---|---|---|---|
| DEO Yield | 4.1% | 3.6% | 3.9% | 3.9% | 3.7% | 3.6% |
| DEO Capital Gains | 13.1% | 3.5% |
-4.8% |
19.1% | 7.6% | 4.3% |
| DEO Total Return | 17.2% | 7.1% |
-0.9% |
23% | 11.3% | 7.9% |
| S&P 500 Return | -10.1% | -10.5% | -23.8% | 22.3% | 9.3% | -4.9% |
Including capital gains, Diageo hands it to the S&P every year.
"Wait! What about 2002?"
I'm glad you asked. In 2002, Diageo realized no capital gains. In fact, the fall in Diageo's stock price wiped out its dividend yield. Since I hate losing money, this should be upsetting. Except that 2002 illustrates the best thing about stock/bonds: Because they pay, investors are hedged against a fall in the price of the stock. Instead of losing 5% in 2002, Diageo shareholders lost less than 1%.
Call me a convert, but this dividend investing is not a bad gig. Since Income Investor recommended Diageo in April 2004, the stock/bond is up 11%. Including dividends, that's an overall gain of almost 15%. As for TiVo, I suffered through its ride and have nothing to show for it.
More money, less risk
Don't get me wrong; I'm not saying dividend stocks carry no risk. Like all investments, there is risk involved. But companies that pay out some earnings from the cash they generate tend to be less risky than their counterparts. Why? Because companies that pay dividends are actually making money. It sounds silly, but there are more than 3,500 public companies that currently report negative earnings. The truth of the matter is: Dividend investing just plain outperforms with lower risk.
I don't know about you, but right now I have money saved that I want to invest without exposing it to a ton of risk. You see, I'm getting married in the fall and my lovely bride-to-be is extremely interested in purchasing a house. Given housing prices, this is not money I can let sit in a savings account, and it is not money I can put in TiVo. I can't afford to watch 25% to 35% of it slip away.
Going forward, my guess is that I'll have a number of situations like this one. For example, I won't want to take huge risks with the money I'm saving for my kids' college fund. Yet, with tuition costs increasing every year, this money shouldn't sit in a savings account, either.
Try a 30-day free trial of Income Investor and you'll see that almost 90% of the recommendations have made money for subscribers. Overall, the portfolio of old reliables -- such as Sara Lee
Making money the old-fashioned way
I stumbled across some analysts today that rate TiVo a "buy" and Diageo a "hold." Two years ago, I thought the same way. With its growth potential, TiVo should've provided more bang for the buck. Should've. Would've. Could've.
Historically, dividends have driven stock market growth, accounting for 40% of returns. And in the past 12 months, while the S&P 500 returned 3% overall, Income Investor selections returned more than 4% on dividends alone! As for long-term growth, consider this example:
If you had invested $1,000 in Kinder Morgan
Good, long-term growth companies pay dividends, and there are simply too many good companies out there to waste time (or money) on any of the borderline or questionable ones. As stock/bonds, strong dividend stocks like Diageo offer a margin of safety by giving a regular rate of return and outpacing the market by offering the opportunity to realize capital gains. So when you're at lunch with your friends in 10 years and they're still claiming they've found the next Microsoft, you can quietly pick up the tab using money that boring, unknown Telecom New Zealand
John D. Rockefeller once said, "Do you know the only thing that gives me pleasure? It's to see my dividends coming in." Like Rockefeller, Mathew Emmert knows solid dividends are one of the few sure things in the market. He writes about them every month so that you can see them come in, too. Take me up on that 30-day free trial of his Income Investor newsletter by clicking here. It's ideal for those of us who hate losing money.
Tim Hanson no longer owns shares of TiVo and does not own any of the other companies mentioned in this article. The Motley Fool has a disclosure policy.
