As a continuation of my article two weeks ago on rebuilding my retirement portfolio, I'd like to delve into why I chose to allocate the majority of my assets to a value and income strategy instead of, say, a market-cap segmentation strategy or more of a growth one.
The income advantage
There are two primary schools of thought on income investing. To generalize a bit, the first believes that dividend payments are a sign of a company entering the slow growth phase of its life -- and hence low return -- and that when compared with stock buybacks, dividends are inefficient because of the tax consequences. The second -- to which I happen to belong -- believes that dividends are a sign of a management team confident in the cash-generating capabilities of its business and that a history of dividend increases, matched with increases in earning power, points to further future price appreciation.
The first argument can be very alluring, particularly when made within the academic confines of people making logical decisions. The fact, however, is that people often don't make logical decisions. Plenty of management teams repurchase overvalued shares, and more often than not, the shares are repurchased only to mitigate the dilution of stock options. Numerous studies show that dividend-paying stocks outperform their non-dividend-paying brethren, and they do so with less volatility.
In this vein, I'd like to share some of the thinking in Jeremy J. Siegel's new book, The Future for Investors, and how I think I can apply it to my own portfolio.
The lessons of a master investor
Before delving into the world of Professor Siegel and his book, it makes sense to look at a bit of recent history first. Few investors have managed to wallop the market over long periods of time; fewer still manage to do it while at the helm of a mutual fund. That said, for a period of 30 years, former mutual fund manager John Neff didn't just beat the market, he throttled it -- and he did so with a heavy focus on dividend-paying stocks.
Over Neff's 30 years at the top of Windsor Fund
During his tenure at Windsor, Neff focused on dividends largely because investors are so focused on earnings that they ignore the fact that a sizable dividend with a bit of capital appreciation can easily exceed the market's return. It also doesn't hurt that above-average dividend yields are by nature almost always paired with low price-to-earnings or price-to-cash flow valuations. As the final piece of the puzzle, Neff also liked the share-price protection that a strong yield offers, because while investors (traders) may ignore a 3% yield in the total return picture, they rarely ignore a yield of 5% or more.
Two dividend-paying examples
Having looked at Neff's performance and a brief synopsis of his total return strategy, let's apply it to a couple of Income Investor picks and how each has performed against its benchmark.
First up is the purveyor of Guinness and numerous other brands of liquor, Diageo
Next up is an Income Investor selection that our family holds in a couple of tax-advantaged accounts already. Health Care REIT's
Foolish final thoughts
The simple fact that we investors need to face is this: The best long-term returns are often found in places that don't call a great deal of attention to themselves. Tootsie Roll
For more on how dividends can add a stable, powerful punch to your portfolio, check out the following articles:
Want to read ongoing coverage of Diageo, Health Care REIT, and other income-producing firms? Take a 30-day free trial of Motley Fool Income Investor to learn more. There's no obligation to buy if you aren't completely happy.