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 on 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, Abbott Laboratories
Source: Capital IQ, a division of Standard & Poor's
There's no ambiguity here: Over time, Abbott's share appreciation alone has paled in importance to the power of its reinvested dividends. The results are similar for competitors Merck
And how do those dividends look? Abbott has paid a dividend every year since at least 1990, growing that dividend at an average annual rate of 10.8%. Its current yield -- 3.6% -- is quite attractive, and indeed higher than the rate on 10-year Treasury bonds. Over the past five years, Abbott's dividend has averaged 40% of free cash flow, which is quite conservative and not only protects its payout, but gives room for future dividend raises.
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.
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Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Abbott Laboratories. Motley Fool newsletter services have recommended buying shares of Abbott Laboratories. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.