The dividend hammer

Sometimes a problem IS a nail and the solution IS a hammer. The famous maxim, ‘to one with a hammer every problem looks like a nail’ is used very often to warn against using the same solutions to solve encountered problems. By the way, this maxim is known as Maslow’s maxim, after Abraham Maslow, the father of modern management technique. But sometimes there is no need for more tools. You just need to find the damn hammer. I liken the problem of long term investment outperformance as a nail. And the best way to drive that nail through the wall and build real long term wealth is with the dividend hammer. Lets look at some recent research that makes this point very clear.

I’ve written about the outperformance of dividends in the past (see here and here) and the supporting research behind it. There is some new research from Credit Suisse that proves the point yet again, that dividends payers outperform non-dividend payers. Lets look at 4 charts from the the Credit Suisse Global Investment Returns Yearbook for 2011.

I love this chart. Besides showing that dividends account for almost half of US stock returns since 1900 it shows how dividends drive performance. That chart shows the annual impacts from dividends and capital gains. The key point is that on an annual basis the impact of capital gains is much larger than dividends but over time the compounding effect of dividends drives investment outperformance. In other words dividends matter more and more as time goes on. Is it any wonder then that many investors still don’t get it? With investment horizons getting shorter and shorter dividends aren’t give the time to work their magic. Next chart.

This chart shows annual returns by type of dividend stocks, from high yielders to zero yielders. Higher yielders outperform medium yielders which outperform low yielders which outperform zero yielders. Seems to make sense but this is very much against much of the conventional wisdom which says higher yielding stocks will be bad performers because all their growth is behind them, that they are dying businesses. Next chart.

This chart shows that the outperformance of high yielders is consistent across the world, it is not just a US phenomenon. In fact, the effect is even more pronounced is foreign developed markets and even some emerging markets like Singapore and Hong Kong. And for the final chart lets really put the nail into the coffin.

Because of this great performance dividend strategies must be riskier than other strategies right? Risk goes hand in hand with return right? There is no free lunch? Well, not only do dividend strategies outperform but they are lower risk. The final figure in the chart, the sharpe ratio, is a measure of risk adjusted returns. Across the 21 counties analyzed since 1900 higher yield strategies have risk adjusted returns nearly 3 times higher than zero yield strategies!

Sometimes there is no need to get creative in problem solving. You just need to realize the solution is staring at you right in the face. Granted, the solution requires overcoming a ton of misinformation and personal behavioral biases that cloud an investor’s vision. But nonetheless, the problem that is long term investment outperformance looks very much like a nail. And the solution is there in the form of dividends. Pick up the dividend hammer!

Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.

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6 Responses to The dividend hammer

  1. J Carroll says:

    Paul, you have mentioned dividend stocks in the past and you have also mentioned using options as a method of generating income. In designing one’s retirement portfolio, do you view dividends as a source of spendable income or as something that should be reinvested for growth/staying ahead of inflation? How do you balance those two potential sources of income? Thank you.

    • libertatemamo says:

      Great question J. I’m finally getting close to publishing what I’ve been building too for a while, my retirement model. Like you noted its a combination of dividend investing and some trading for income. Not to keep you in too much suspense, I basically have a portfolio of dividend/income investments that generate enough income to cover my retirement expenses and I reinvest those dividends. I then keep 20-30% of my portfolio in cash to trade and try and generate enough income to cover my retirement expenses – and then I actually use this income to live. If I can’t generate enough income by trading to cover expenses then I don’t reinvest whatever part of my dividend portfolio I need to make ends meet. I’m trying to have my cake and eat it too….

  2. Pontus Lindqvist says:

    Great blog post! Could you please provide us with a link to the original source of your charts? Would love to read more around this!


  3. J Carroll says:

    Paul, I look forward to your retirement model. If possible, hope you can include a few names that are candidates for inclusion in some of the categories of the model. Thanks for the response and the blog.

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