Over the past 40 years, stocks that increased or initiated dividends produced an average annual return of 13.74% vs. a 9.6% return for non-dividend-paying stocks.
Imagine asking someone for a stock tip, and they suggested investing in a cereal company or a manufacturer of car parts. With the popularity of artificial intelligence, biotechnology and electric vehicles, you’d probably laugh in their face.
Now imagine that advice came from legendary investors Warren Buffett or Peter Lynch. Buying shares of companies making breakfasts and mufflers wouldn’t see as ludicrous, would it?
Buffett and Lynch understand the importance of compound interest and time in the market … not timing the market. And for that reason, companies like General Mills (GIS) and Genuine Parts (GPC) fit the bill.
General Mills and its predecessor firm have paid uninterrupted dividends for 124 years. And Genuine Parts, a Dividend King, has raised its dividend yield 67 years in a row.
It doesn’t matter if you think cereal is trash food or if you lease your vehicle and never worry about maintenance. Food inflation is 5.7% above last year and the average new car now costs nearly $50k.
Consequently, car owners are increasingly repairing their vehicles instead of purchasing new ones. Earlier this month, Axios reported that the cost of car repairs rose 19.7% year over year.
And while we agree that cereal is trash food and there’s nothing terribly exciting about brake pads … the companies producing them are in terrific shape.
In Tuesday’s issue of The 101, we talked about dividend-paying stocks, how they work and why everyone should own them. Today, as with all issues of The Big Idea, we’ll explain how to apply that knowledge to the market.
But before we do, we need to briefly discuss what people mean when they say, “the market,” what its 11 sectors are and which ones are inelastic in demand.
Exchanges vs. Indices
There are numerous exchanges that permit companies to publicly trade securities. Wall Street’s New York Stock Exchange. The Nasdaq. The London Stock Exchange.
On the other hand, stock indices are groupings of stocks listed on various exchanges that measure gains or losses in the broad market.
Examples include:
- The Dow Jones Industrial Average, which tracks blue-chip stocks.
- The Nasdaq Composite, which tracks the tech-heavy stocks of its namesake exchange.
- And the Standard and Poor’s 500 (S&P 500).
When people say, “the market,” the S&P is typically what they’re referring to. The S&P tracks the performance of the 500 largest companies listed on stock exchanges in the U.S. And it does so by breaking them down into sectors.
The S&P 500’s Sectors
For everything you can buy or sell, whether a product or service, there’s a category for it. Food? Consumer staples. Medicine? Healthcare. Real estate? Well … real estate.
The S&P applies these to all of its 500 companies. In total, there are 11 sectors. And in times of economic uncertainty, persistently high inflation or when recession could be looming, it’s the sectors with inelastic demand that tend to perform better than the rest.
Think wants vs. needs. When household budgets are squeezed, wants like vacations (consumer discretionary) and additional iCloud storage (information technology) give way to needs like food (consumer staples), electricity (utilities) and gas (energy).
Given their inelastic demand, it’s unsurprising that companies that fall into those sectors perform well year in and year out … often while paying significant dividend yields.
That’s because no matter what those companies charge, consumers will pay for it. Consumers will always needs to put gas in their cars, food on the table and clothes on their children.
5 Strong Dividend-Paying Stocks
Within those sectors, there’s no shortage of stocks paying average-beating dividend yields.
Whether it’s Dividend Kings, Dividend Aristocrats or real estate investment trusts (REITs) — who by law must pay 90% of their taxable income to shareholders are dividends — there are hundreds of established companies that pay you to own their shares.
Here are five examples:
1. Genuine Parts pays a 2.25% annual dividend yield, or 95 cents per share quarterly. The auto part maker’s stock has risen 82% over the past five years.
2. Prologis (PLD) pays a 2.77% annual dividend, or 87 cents per share quarterly. The industrial REIT — which is the largest in the world — has seen its stock rise 91% over the past five years.
3. General Mills pays a 3.16% annual dividend yield, or 59 cents per share quarterly. The processed food manufacturer’s stock has risen 68% over the past five years.
4. Target (TGT) pays a 3.28% annual dividend, or $1.10 per share quarterly. The retail giant’s stock has risen 73% over the past five years.
5. And AbbVie (ABBV) pays a whopping 4.35% annual dividend yield, or $1.48 per share quarterly. The pharmaceutical company’s stock has risen 41% over the past five years.
Five-year performance of GIS (dark blue), GPC (orange), ABBV (light blue), PLD (yellow) and TGT (purple).
Of those five, Target, AbbVie and Genuine Parts are all Dividend Kings, meaning they have raised their dividend yields for at least 50 consecutive years.
Dividend Calculator
Beyond dividend royalty, there are massive dividend yields you can add to bolster your portfolio’s returns. By using a dividend calculator, you can see just how impactful those yields can be.
Petróleo Brasileriro (PBR), a Brazil-based petroleum company, helps paint a picture of how it’s beneficial to own high-dividend-paying stocks — and importantly — reinvesting those dividends.
The company pays an absurd 21.78% annual dividend yield, or 75 cents per share quarterly, and has raised its dividend 11 times in the past five years, good for 141.34% annualized dividend growth.
At the time of writing, shares are trading for $13.80. That means:
- If you purchase 500 shares in a Roth IRA (wherein gains aren’t taxed if you wait until the age of 59.5 and have held the account for at least five years).
- If you use a dividend reinvestment plan (DRIP).
- If PBR maintains its dividend yield without ever raising it again.
- And if its shares never gain a penny (highly unlikely as Brazil is about to become the 4th largest oil producer in the world) …
That initial purchase of 500 shares for $6,900 could be worth over $355k in 20 years — a 920.45% yield on the initial cost.
Now consider that the above circumstances remain the same, BUT you commit to dollar-cost averaging and purchase an additional $500/year of PBR’s stock. That $6,900 could instead be worth over $470k in 20 years.
Of course, global oil demand could dry up as the world transitions to renewable energy. And PBR’s stock could tank … but since its March 2020 low when the pandemic struck and oil demand cratered, shares are up 184%.
But the idea remains: Using the power of compound interest to maximize the returns of dividend-paying stocks is precisely why dividends have accounted for 40% of market returns since 1930.
TL;DR
Dividend stocks historically outperform the market, but the best one-two punch for portfolio success is (1) finding dividend-paying and dividend-growing stocks (2) in sectors with inelastic demand. Those companies aren’t flashy, but they provide the goods and services consumers need. Use a DRIP to reinvest dividends and take advantage of compound interest for substantial long-term returns. Remember to conduct your own due diligence.
Resources
- Dividend Kings: Companies that’ve raised their dividends for 50+ years.
- Dividend Aristocrats: Companies that’ve raised their dividends for 25+ years.
- S&P 500: Performance breakdown of the index’s 11 sectors.