Why Dividends Stock?

WHY DIVIDEND STOCKS?

Let me start by making a bold statement: The ideas in this book are one of the most important gifts you can give to yourself or your children. On the pages that follow is the recipe for generating 11% yields and 12% average annual returns for your portfolio. Significantly more if the stock market or your particular stocks cooperate.

I’m not trying to brag. I wasn’t the one who thought up this strategy. I just repackaged it in a compelling, easy-to-read book that you will want to buy more copies of for all your friends and family. Or at least lend them yours.

If you follow the ideas in this book and teach them to your children, it’s very conceivable that many of your concerns about income in the future will be over. And perhaps just as important, if your children learn this strategy at a young age, they may never have financial difficulties. They will have the tools to set themselves up for income and wealth far before they are ready to retire.

Keep in mind that I cannot teach you or your kids how to save. If you would rather buy a new car at the expense of putting money away, I can’t and won’t attempt to fix that. This book is for the people who already know how to save and are trying to make that money work as hard as they do.

As far as saving money is concerned, the only advice I’ll offer can be found in one of my favorite finance books, The Richest Man in Babylon, by George S. Clason. In that book, first published in 1926, Clason writes: “For every ten coins thou placest in thy purse take out for use but nine. Thy purse will start to fatten at once and its increasing weight will feel good in thy hand and bring satisfaction to thy soul.”

Many personal finance gurus proclaim the same advice, but with a more modern bent to it, stating “Pay yourself first.”

Even if you are not able to save 10% of your current income, saving anything is crucial. As you will see, the money you save and invest using the ideas in this book will grow significantly over the years. So if you can only save 8% or 5% or even 2%, start doing it now. And if you get a raise or an inheritance or win the football pool, do not spend a dime of it until you have put away 10% of your total income.  

Here are some scary statistics. According to the Employee Benefits Research Institute, only 14% of Americans believe they will have enough money to retire comfortably. Even worse, 60% of workers reported household savings of less than $25,000.

If you are serious about improving your family’s financial future—and I know you are because you’re investing the time to read this book—start saving today, if you haven’t already.

Imagine if you saved 10% of your money and put it into the kinds of dividend stocks discussed in this book. Over time, your wealth should grow to the point that it will have generated significant amounts of income, perhaps even replacing the need to work.

This is the last point I will make about saving. You didn’t spend your money on this book (or drive all the way to the library) just to have me beat you up about saving. Instead, I will assume you really are serious about securing your future and want to learn how to take those funds and add a few zeros to the end of the total number in your portfolio.

And if you’re already retired and need income right away, the strategies in this book can help you too. You may not have the ability to compound your wealth, but you can invest in companies that will generate more and more income for you every year. Not only can you beat inflation, but you can also give yourself and even your loved ones an extra cushion.

There are lots of ways to invest your hard-earned money. But you’ll soon see why investing in dividend stocks is a conservative way to generate significant amounts wealth and income. This isn’t theory. It’s been proven over decades of market history.

Some people believe that real estate is the only way to riches. Others say the stock market is rigged so that the only people who make money are the professionals—therefore, you should be in the safety of bonds. Still others only trust precious metals. None of these beliefs is true at all.

Within the stock market, there are various strategies that are valid. Value investors insist you should buy stocks when they’re cheap and sell when they’re expensive. Growth investors believe you should own stocks whose earnings are growing at a rapid clip. Momentum investors suggest throwing valuation out the window and investing in stocks that are moving higher—and getting out when they stop climbing.

Still others only trust stock charts. They couldn’t care less what a company’s earnings, cash flow, or margins are. As long as it looks good on the chart, it’s a buy.

Each of these methodologies works at some point. Value and growth strategies tend to switch on and off: One will be in favor while the other is out until they trade places. For one stretch of time, value stocks outperform. Then for another few years, growth will be stronger. Eventually, value will be back in fashion.

Whichever is in vogue at the moment, supporters of each will come up with all kinds of statistics that prove their method is the only way to go.

The same dynamic applies when it comes to fundamentals versus technicals. The technical analysts who read stock charts assert that everything you need to know about a company is reflected in its price and revealed in the charts. Fundamental analysts, who study the company’s financial statements, maintain that technical analysis is akin to throwing chicken bones and reading tealeaves.

There are plenty of other methodologies as well. These include quantitative investing, cycle analysis, and growth at a reasonable price (GARP) to name just a few more.

Diehard supporters of all these strategies claim that their way is the only way to make money in the markets. It’s almost like a religion whose most fanatical followers act as if their beliefs are the only truth—period, no debate, end of story. They’re right and you’re wrong if you don’t believe the same thing they do.

I’m no authority when it comes to theology. But when it comes to investing I know this: Dogma does not work.

You will not consistently make money investing only in value stocks. Again, sometimes they’re out of favor. If you only read stock charts, sometimes you’ll be wrong. Charts are not crystal balls.

Quantitative investing tends to work until it doesn’t. Just ask the investors in Long Term Capital Management, who lost everything in 1998.

Long Term Capital was a $4.7 billion hedge fund that utilized complex mathematical models to construct trades. It made a lot of money for investors for several years. It was supposed to be fail-proof. But like the Titanic, which was also supposed to be unsinkable, Long Term Capital hit an iceberg in the form of the Russian financial crisis and nearly all was lost.

 “Y’all Must’ve Forgot”

During his prime, legendary boxer Roy Jones Jr. was one of the best fighters that many fans had ever seen. However, Jones didn’t seem to get as much respect as he thought he deserved. So, in 2001, he released a rap song that listed his accomplishments and reminded fans about just how good he was. The song was titled “Y’all Must’ve Forgot.” Roy was a much better fighter than he was a rapper. The song was horrendous.

Looking back, investors in the mid- to late 1990s remind me of boxing fans in 2001, when Roy released his epic tribute to himself. Both groups seemed to have forgotten how good they had it—boxing fans no longer appreciated the immense skills of Jones, while investors grew tired and impatient with the 10.9% average annual returns of the Standard & Poor’s (S&P) 500 (including dividends), since 1961. After decades of investing sensibly, in companies that were good businesses that often returned money to shareholders in the form of dividends, many investors became speculators, swept up in the dot-com mania.

I’m not blaming anyone or wagging my finger. I was right there with them. During the high-flying dot-com days, I was trading in and out of Internet stocks too. My first “ten bagger” (a stock that goes up ten times the original investment) was Polycom (Nasdaq: PLCM). I bought it at $4 and sold some at $50 (I sold up and down along the way).

However, like many dot-com speculators, I got caught holding the bag once or twice as well. I probably still have my Quokka stock certificate somewhere in my files. Never heard of Quokka? Exactly. The company went bankrupt in 2002.

With stocks going up 10, 20, 30 points or more a day, it was hard not to get swept up in hysteria.

And who wanted to think about stocks that paid 4% dividends when you could make 4% in about five minutes in shares of Oracle (Nasdaq: ORCL) or Ariba (Nasdaq: ARBA)?

Did it really make sense to invest in Johnson & Johnson (NYSE: JNJ) at that time rather than eToys? After all, eToys was going to be the next “category killer,” according to BancBoston Robertson Stephens in 1999. Interesting to note that eToys was out of business 18 months later and BancBoston Robertson Stephens went under about a year after that.

If, in late 1998, you invested in Johnson & Johnson, a boring stock with a dividend yield of about 1.7% at that time, and reinvested the dividends, in late 2011, you’d have made about 8.6% per year on your money. A $3,000 investment would have nearly tripled.

Johnson & Johnson is a real business, with real products and revenue. It is not as exciting as eToys or Pets.com or any of the hot business to business (B2B) dot-coms that took the market by storm.

But 13 years later, are there any investors who would complain about an 8.6% annual return per year? I doubt there are very many— especially when you consider that the S&P 500’s annual return, including reinvested dividends, was just 2% during the same period.

Now, you might have gotten lucky and bought eBay (Nasdaq: EBAY) at $2 per share and made 16 times your money. Or maybe you bought Oracle and made 5 times your money. But for every eBay and Oracle that became big successful businesses, there were several Webvans that failed and whose stocks went to zero.

In the late 1990s, the stock market became a casino where many investors lost a ton of money and didn’t even get a free ticket for the buffet. It doesn’t seem that we’ve ever completely returned to the old way of looking at things.

My grandfather, a certified public accountant who owned a seat on the New York Stock Exchange, didn’t invest in the market looking to make a quick buck. He put money away for the long term, expecting the investment to generate a greater return than he would have been able to achieve elsewhere (and possibly some income).

He was willing to take risk, but not to the point where he was speculating on companies with such ludicrous business ideas that the only way to make money would be to find someone more foolish than he to buy his shares. This is an actual—and badly flawed theory used by some. Not surprisingly, it is called the Greater Fool Theory.

There were all kinds of companies, TheGlobe.com, Netcentives, Quokka, to name just a few, whose CEOs declared we were in a new era: This time was different. When I asked them about revenue, they told me it was all about “eyeballs.” When I pressed them about profits, they told me I “didn’t understand the new paradigm.”

Maybe I didn’t (and still don’t). But I know that a business has to eventually have revenue and profits. At least a successful one does.

I’m 100% certain that if Grandpa had been an active investor in those days, he wouldn’t have gone anywhere near TheGlobe.com.

One principle that I believe many investors have forgotten is that they are investing in a business. Whether that business is a retail store, a steel company, or a semiconductor equipment manufacturer, these are businesses run by managers, with employees, customers and equipment and, one hopes, profits. They’re not just three- or four-letter ticker symbols that you enter into Yahoo! Finance once in a while to check on the stock price.

And these real businesses can create a significant amount of wealth for shareholders, particularly if the dividend is reinvested.

According to Ed Clissold of Ned Davis Research, if you invested $100 in the S&P 500 in at the end of 1929, it grew to $4,989 in 2010 based on the price appreciation alone. However, if you reinvested the dividends, your $100 grew to $117,774. Clissold says that 95.8% of the return came from dividends.1 (See Figure 1.1.)

Figure 1.1 1929-2010: $100 Original Investment

Marc Lichtenfeld’s Authentic Italian Trattoria

Years ago, my wife and I were in Ashland, Oregon. We loved the town and started talking about escaping the rat race, moving to Ashland, and opening a pizza place. We’ve repeated that conversation on trips to Banff in the Canadian Rockies, Asheville, North Carolina, and even Tel Aviv, Israel.

Considering that I know nothing about how to run a restaurant, would be unhappy if not in close vicinity to a major American city, and am a lousy cook, the pizza joint remained a happy fantasy.

But for the purposes of this book, Marc Lichtenfeld’s Authentic Italian Trattoria will serve as an example of a business with revenue and profits. We’re also going to assume that I’m your brother-in-law (your sister was always a very good judge of character) and you’ve agreed to become my partner in the business.

One day I come to you, my favorite brother/sister-in-law, with my plans for the restaurant. I have the space lined up. It’s in a popular location with a lot of foot traffic. I’ve been talking with a wonderful young chef who is eager to make an impression on local diners and critics. All that’s missing is start-up capital.

This is where you come in. In exchange for a $100,000 investment, you will receive a 10% ownership stake. I show you my projections: The restaurant will break even the first year, make $100,000 in the second year and $200,000 in the third year.

One of the questions you may have is how you’ll get your money back. Do you have to wait for the restaurant to be sold, or will you receive some of the profit each year?

If I tell you that my goal is to build the business to $1.5 million in sales and then sell it for two times sales ($3 million), where you’ll receive $300,000, your response might be very different from what it would be if I tell you that half the profits will be invested back in the business with the other half split up among the partners in a yearly payout (dividend).

Your decision on whether to give me the money will depend in part on your goals. Are you willing to speculate that you’ll receive the big payoff in several years when the business is sold, or would you rather receive an income stream from your investment but no exit strategy (plan to sell the restaurant)?

When buying stocks, investors have to make similar decisions. Do they buy a stock with the sole purpose of selling it higher down the road, or do they buy one that provides an income stream and opportunities for income growth in addition to capital gains?

I don’t know about you, but if I’m investing in someone’s business, I want to see some money as soon as possible rather than wait for an exit strategy.

Here is another factor that might affect your decision to invest in my trattoria: Instead of offering to pay you your cut of the profits ever year, I might offer to reinvest that money back into the restaurant and give you more equity. That way, your piece of the profits gets larger each year. Eventually, you can start receiving a significant cash payout on an annual basis or receive a bigger slice of the pie when you sell your stake in the business because your equity has increased above your original 10%.

This last scenario is the same as reinvesting dividends, a method that is the surest way I know of to create wealth.

And what I love about this strategy is that it works (and has worked) no matter who is President of the United States; what hap-pens in Europe, Iran, or the Middle East; unemployment; inflation; and so on. Sure, those things will impact your short-term results, but over the long haul, they mean nothing and in fact could help you accumulate more wealth, as I’ll explain in the section on bear markets in Chapter 3.