Dividends Are Overrated
Don't Forget About Total Return In Stock Investing
Dividends are overrated? This is heresy if you ask any of the hundreds of dividend stock investing and early retirement websites. Today we'll review the role of total return in stock investing versus a dividend only strategy. If this is your first time visiting I thank you for your time. For a little background we are investors in individual stocks. Much of our gain the past 5 years since we took out the trash in 2016 have been from growth stocks which pay little or no dividends. If you want to see what is in our portfolio here is the latest update: November Year to Date Stock Scorecard – Smidlap +84.0%, QQQ +39.5%, VTSAX +13.3%.
5 Year Chart of Our Performance versus QQQ and VTSAX. We are the blue line.
We are not "against" dividends
Of the 35 stocks we owned as of a few weeks ago 11 of them paid a regular dividend. A small handful of those happen to be some of our worst performers so far, but we'll hold onto them because we believe in the long term prospects of the companies. The best dividend paying performers in the portfolio happen to have the smallest payout relative to price even though the dividends are all growing regularly. Companies like Nvidia and Mastercard have yields of less than 1% currently but the share prices have done quite well. When I say dividends are overrated what I really mean is I would not throw out all the non-dividend payers like high quality growth stocks in order to build a balanced diverse stock portfolio. Why limit yourself? It can't be solely for a favorable tax rate in retirement. After all if you are a buy and hold investor like us you will end up with many long term holdings. We define these as held more than one year and many of those are held much longer than that. While I'm not a tax expert or finance professional I know the federal capital gains tax on long term holdings is the same as the tax on qualified dividends. Check out this on Investopedia regarding How Capital Gains and Dividends Are Taxed
In the case of qualified dividends, these are taxed the same as long-term capital gains, as of 2020, individuals in the 10% to 15% tax bracket are still exempt from any tax. Investors who fall in the middle brackets—25%, 28%, 33%, or 35%—pay 15% at most in capital gains.
A case study in telecom stocks
We don't usually like to look backward when it comes to investing. After all, anyone can be a Monday morning quarterback and tell you a result for something that has already happened, right? However I can't help but think back to 2017 when I started writing this blog and seeing dividend growth investors buying at stock like AT&T ($T) for the juicy 4-5% dividend yield. I cringed when I saw that because I thought AT&T's best days were well behind them and they were not a well run disciplined company. Here is what happened if an investor spend $1000 of their hard earned dollars on T stock at $33.17/share at the end of 2015.
Even with those fat dividends reinvested and compounding for 5 years the end result is that investor was sitting on a whopping $1160. So, because of share price decline the total return on investment was only 16%. The S&P 500 returned around 80% over the same time period so I would call this investment a bust (so far). There are people who will tell you that they don't care because they can reinvest and buy the shares cheaper but sometimes the share price never rebounds back to prior levels or even higher. If you are anything like us you know the share price is an important piece of total return. Meanwhile, we'll take a look at another odious telecom company in Verizon ($VZ) over the same period. They also paid out a pretty chunky dividend north of 4% back in early 2016. This is how you did if you invested $1000 in VZ and reinvested the dividends for 5 years.
Verizon sucks a little less than AT+T
Verizon did suck a little less than filthy AT&T but still lost slightly to the S&P 500 over the same period. You would have ended up with a 70% total return for 5 years. That is not terrible as the stock price rose from around $45 to around $60. Around the same time the Smidlap Portfolio owned shares of growing and well run telecom competitor T-Mobile ($TMUS) back in 2016. We should have kept that one but we sold for what we thought was a better opportunity in 2018. The point is not regret over getting rid of a good well run company it is this: TMUS did not pay a dividend and still does not. Here are the returns, though. If you spend $1000 on TMUS stock in late 2015 for $36/share and waited 5 years until December of 2020 the shares are worth $133.60. My razor sharp math skills tell me that 271% gain would leave you with $3711. Dividends are overrated this time. It doesn't matter which phone company you are loyal to or has the best coverage or pays the best dividend. All that matters is which one makes you the most money as an investment!
So What?
If you don't like the telecom industry for an example let's take a look at the beer industry instead. I had Anheuser-Busch ($BUD) on a dividend stock watch list and realized they have plummeted. I then heard that Boston Beer Company ($SAM), who makes Samuel Adams beers had been doing well. We have never owned either one so I had to investigate. I figured SAM might pay a dividend but I was wrong. I then added another competitor, Molson-Coors ($TAP), to the search. It turns out TAP used to pay a dividend but must have suspended it earlier in 2020. Take a look at the 5 year chart with SAM in purple and the laggards in the 2 blue lines.
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The dividends aren't going to save you when TAP and BUD share prices are down more than 40% each over the past 5 years! Meanwhile the good folks at SAM have seen their shares soar more than 390% in the same time period. They did it all without any dividend payouts. That's why when we invest we're not throwing the ball where the receiver has been but where she is going. Think Samuel Adams beer sucks? It doesn't matter the same as if you don't like T-Mobile's customer service or cellular coverage. Once again, my point is not to say all dividends are overrated. Some well run companies who have matured out of their rapid growth stages have initiated dividends or increased them along with their share prices over the past 5 years. Think of companies like Apple, Microsoft, Cintas, and Sherwin Williams. They continue to execute well and dominate their industries.
Some other reasons dividends are overrated
If you want to own companies just for the income are you even retired yet? If not you can own some growth stocks or even a growth oriented ETF like QQQ or VGT and then transition to income stocks when you will be spending the income. Why limit yourself when there are tremendous investment opportunities with no present dividend payout.
If you are absolutely married to the idea of a dividend-only portfolio I have one observation for you. Beware high yields like Verizon and AT&T had 5 years ago. Often times the best of the mature dividend paying companies have yields of less than 2%. That's because the share price has risen as they continue to operate their businesses well.
You might get stuck with something like a large banking institution or fossil fuel company for your dividends. Those whole industries have been doing terribly for the past 10 years or more. If you wanted an energy company there are plenty of solar stocks like SolarEdge (we own that one). Or even a renewable energy utility like Brookfield Renewable Partners who are just getting started with plenty of growth ahead. If you like financial companies you don't have to be stuck with an old cruddy dividend paying bank like Wells Fargo but maybe a fin-tech company like PayPal or Square who pays no dividend is a better choice.
Some of these growth stock winners are the dividend payers of the future! Think about that. They can't spend all their free cash flow on growth in perpetuity. As they mature and win business these upstarts could very well be paying you a quarterly paycheck in 10-20 years. Meanwhile many of these shares just continue to appreciate.
late edit: My buddy Mr. Fate over at Fates on FIRE blog reminded me of something in the comments section that deserves a word. He explained that he is living off dividends but not necessarily planned that way. The message I take away from that is whatever style you choose for your investing buy high quality companies and the rest will take care of itself.
So there you have it, Smidlappers. Have I sold you on the fact that dividends are overrated? Have any of you ever even spent a dividend payout from a stock or a fund? I hope the backlash from all the "dividend or die" crowd is swift and strong on this misguided opinion. disclosure: we own shares of SolarEdge, Square, and PayPal at the time I wrote this. Remember, I am not a financial professional but merely offer opinions to consider. Do your own research and get help from a pro if you need it. But...keep reading here to see you we do.