I guess it's some small comfort that illustrious General Electric, bluest of blue chips and the only remaining constituent of the original Dow Jones Industrial Average, just hiked its dividend for the third time in a year. Anyone who has held it for the past decade needs every extra penny GE can dole out.
The stock is off 58 percent on a share-price basis over the last 10 years, according to data from Capital IQ, but down just a smidge more than 40 percent after adjusting for dividends.
So thank goodness for dividends. And happily, they're making a comeback.
In just the last week more than a dozen S&P 500 companies announced dividend hikes, according to Capital IQ. Amgen's about to pay a dividend for the first time in its history. Southern Corp. just hiked its already pretty generous payouts, while Whirlpool and Travelers also joined the club of recent raisers.
True, there are plenty of knocks against dividends. Among the caveats: Dividends get taxed twice -- first as corporate earnings and then again as an individual capital gain. Dividends also limit management's options when it comes to investing in R&D or making acquisitions (sometimes that's a good thing). Perhaps worst of all, too often individual investors waste the income, trying to live off the often paltry and frequently uncertain stream of payments.
For long-term investors, reinvesting dividends can make all the difference in total returns. The crucial key is to invest in companies that not only reliably pay their dividends, but also have a history of consistently raising them. That's because every time the board of directors hikes the dividend, the yield on your cost of capital -- your cost basis -- goes up.
And over time that rising yield can get make your greedy little eyes bulge out.
To illustrate the way it works we'll keep the math super simple: You buy one share of stock for $10. The company pays an annual dividend of $1 a share. That makes your dividend yield 10 percent. (Fantasy numbers, I know, but we're keeping it simple here.)
A few years down the line the stock is up to $20 but the company is still paying just that $1 dividend. That means new investors coming in at $20 a share are getting a yield of just 5 percent. So the board decides to hike the dividend to $2 a share, making the yield -- once again -- 10 percent.
Recall, however, that you bought at $10. Your dividend payout is now $2 a year. The dividend yield you oh-so-wise-and-patient investor enjoy is now sitting at 20 percent. (Not to mention you doubled your share price. Damn, you're good.)
Reinvesting dividends over long periods of time can also save you from disaster. For example, Wal-Mart has been a dog over the last 10 years on a share-price basis. It's up about 3 percent -- pretty much worse than dead money after accounting for inflation. But adjusted for dividends, Wal-Mart is up close to 20 percent. Have a look at this chart created with data from Capital IQ.
The crucial point, once again, is to find companies with a long history of consistently raising their dividends. For that you can turn to Standard & Poor's Dividend Aristocrats, an index that measures the performance of companies in the S&P 500 that have hiked dividends every year for at least 25 consecutive years. Here's the current roll call, courtesy of S&P: