7/13/08

The Power of Investing in Dividend Paying Companies

Suppose 20 years ago, in the middle of the Savings and Loan Crisis, you decided to invest in a basket of dividend paying companies to hold for the long term. Not wanting to do too much research but still interested in buying quality companies, you decided to invest in those Dow Jones Industrial Average components that paid dividends at the time. You cashed the dividend checks, but left your portfolio alone. How would your investment have done until now (as of market close July 11, 2008)?

In July 1988, the 30 companies in the Dow were:

Allied-Signal Incorporated
Aluminum Company of America
Primerica
American Express Company
AT&T
Bethlehem Steel
Boeing Company
Chevron
Coca-Cola
Du Pont
Eastman Kodak Company
Exxon Corporation
General Electric
General Motors Corporation
Goodyear
International Business Machines
International Paper Company
McDonald’s Corporation
Merck & Company, Inc.
Minnesota Mining & Mfg
Navistar International Corp.
Philip Morris Companies
Procter & Gamble Company
Sears Roebuck & Company
Texaco Incorporated
Union Carbide
United Technologies Corporation
USX Corporation
Westinghouse Electric
Woolworth

Bethlehem Steel, which went out of business in 2001, and Navistar (NAV) did not pay dividends at the time, so let's say you bought the other 28 companies. Suppose you invested $100 in each (total investment of $2,800).


Here's a bit about some of the potentially unfamiliar names.

Allied-Signal is the predecessor of the diversified technology and manufacturing company we now know as Honeywell (HON). It was recently taken out of the DJIA. Aluminum Company of America is called Alcoa (AA) today.

Formerly American Can, Primerica once produced aluminum cans. It shifted its focus to finance in the late 1980s. Primerica became Traveler's Group, and later merged with Citicorp to become Citigroup (C). A record breaker at the time, the deal involved Traveler's paying $70 billion for Citi stock, creating the world's largest bank.

If you think you never heard of International Business Machines, you probably call it IBM. If Minnesota Mining and Manufacturing seems somewhat unfamiliar, that's because today it's called 3M (MMM).

Philip Morris, food and tobacco products maker, became Altria (MO), and has since spun off Kraft (KFT) and Philip Morris International (PM). Altria was recently taken out of the DJIA along with Honeywell.

Texaco, an oil company, was bought by Chevron (CVX) in 2001. Chevron was a DJIA component in 1988, was subsequently taken out, and is now back in. Union Carbide, maker of petrochemicals, was acquired by Dow Chemical (DOW) in 2001.

USX Corp spun off US Steel (X) and changed its name to Marathon Oil (MRO). Westinghouse Electric, a diversified business, became CBS in 1997 and was sold to Viacom (VIA VIA-B) in 1999.

Woolworth sold various consumer goods. After experiencing difficulties, it went by the name Venator for a short time, before adopting the name of its leading store, Foot Locker (FL).


So how did the portfolio do?

First, there are two sets of returns. One includes AT&T (T), and one does not. I found it a bit confusing which AT&T was which, and what the available financial data referred to. Comedian Steven Colbert once expressed his own puzzlement. Here's a link to the video. (I don't know how long it'll work or whether the site has Viacom's permission to post it.)

Second, the results are understated. That is, actual results would have been better than the ones described below. I had trouble finding data on Sears, so for my purposes here, I'm assuming investing in it 20 years ago would have resulted in a total loss (this would not have happened had you actually invested in it).

I also had some trouble finding detailed data on the companies that were acquired (Texaco, Union Carbide, Westinghouse). To figure out their returns, I found the number of shares outstanding in 1988 for each of them by looking at their annual reports, and multiplied this number by their highest share price of the year, determining their highest 1988 market cap. Had you actually bought them in July 1988, you would almost certainly pay less than the price I assume here. Once I had the market cap, I found out how much the companies were purchased for, and determined the return from the difference.

From July 1, 1988 to July 11, 2008, the portfolio's return with AT&T is 430.34%. Without AT&T, the portfolio returned 421.94%. (The return without AT&T assumes that investing in AT&T in 1988 resulted in a total loss. That is, I'm still assuming that 28 stocks were purchased). Your $2,800 portfolio would today be worth almost $14,900 (over $14,600 without AT&T).

Remember, in light of the above, that actual returns would have been greater. Also, these figures do not take into account the dividend payments you would have received over the two decades. Nor do they reflect the extra companies you would now own had you actually invested the $2,800 in 1988.

These returns of 430.34% (a little over 8.68% annually) and 421.94% (a little over 8.59% annually), while not earth shattering by any means, compare very favorably with the market's performance over the same period. From July 1988 to now, the S&P 500 has advanced 356.06% (around 7.86% annually).

But you invested in dividend paying stocks, so how much would your investments be paying you today? With AT&T in the portfolio, you would receive $453.04 in dividends this year. That's over 16% of your original investment this year alone. If dividends remain steady, they will double your original investment around every four and a half years. Without AT&T, you'd get $436.61 this year.

The returns and dividends reflect both terrible performance by some stocks and great performance by others. The portfolio beat the S&P 500 because the winners greatly outpaced the losers. For example, while Goodyear, General Motors, and Woolworth have been lousy, GE, Philip Morris, and Procter & Gamble, to name a few, have been fantastic. On your original $100 investment in Philip Morris, for instance, you'd get over $72 in dividends this year alone (not counting Kraft or Philip Morris International, which also pay dividends). If Altria's dividend remains the same, you will more than double your original investment in Philip Morris every two years. As another example, as long as dividends remain steady, GE will pay you almost $40 on your original $100 investment every year from this point on.

There are a couple of morals we can draw from this story. One is that you can be a lazy investor and still beat the market. A better moral is that great companies (here by virtue of their DJIA membership) that pay dividends can be market beating investments if you hold them for a long time. If you hold them long enough, the dividends alone on some might double your original investment every year.

Another lesson to draw is that diversification pays off. Picking only a few dividend stocks might have given you superior results, but you also could have picked a bunch of losers. By buying a basket of great companies (whatever your criteria for greatness might be, in this example it's DJIA membership), you shield yourself against some inevitable losses.

I don't know how long this blog will be around, but I'll start the same lazy portfolio with today's DJIA stocks. There are a bunch of financials in the Dow today. Who knows how much lower they'll go. On the other hand, they will recover eventually, and over the long term they might be good investments. We'll see. While right now it's pretty much the same as keeping track of the DJIA, the index's components will change in the future while the sample portfolio's holdings will remain the same.

Here are the current DJIA stocks (they all pay dividends) with their prices as of Friday's (7/11/2008) market close:

ALCOA INC 34.64
AMER INTL GROUP INC 23.08
AMER EXPRESS INC 39.21
BOEING CO 63.28
BK OF AMERICA CP 21.67
CITIGROUP INC 16.19
CATERPILLAR INC 69.81
CHEVRON CORP 92.25
DU PONT E I DE NEM 41.47
WALT DISNEY-DISNEY C 29.20
GEN ELECTRIC CO 27.66
GEN MOTORS 9.92
HOME DEPOT INC 21.58
HEWLETT PACKARD CO 41.59
INTL BUSINESS MACH 122.12
INTEL CP 20.64
JOHNSON AND JOHNS DC 66.26
JP MORGAN CHASE CO 33.16
COCA COLA CO THE 50.27
MCDONALDS CP 57.32
3M COMPANY 68.72
MERCK CO INC 36.75
MICROSOFT CP 25.25
PFIZER INC 17.81
PROCTER GAMBLE CO 63.45
AT&T INC. 32.58
UNITED TECH 60.69
VERIZON COMMUN 34.92
WAL MART STORES 56.29
EXXON MOBIL CP 85.48

I'll also track a few dividend ETFs (with prices as of market close on 7/11/08), as they also attempt to track the performance of great dividend paying companies.

PowerShares Dividend Achievers Portfolio ETF (PFM)
14.20

First Trust Morningstar Dividend Leaders Index Fund ETF (FDL) 14.07

Claymore/Zacks Yield Hog ETF (CVY)
19.85

iShares Dow Jones Select Dividend Index Fund ETF (DVY) 47.62

WisdomTree Total Dividend ETF (DTD)
45.75

Vanguard High Dividend Yield Index ETF (VYM)
42.07