July 26, 2013

Brian and Bo tackle the challenge of explaining how yield can affect the overall performance of a portfolio. They share historical numbers and some great quotes that reference the importance of making solid investments that keep dividend yield in mind.

This week’s show is based on a book the guys read on vacation: Shareholder Yield- A Better Approach to Dividend Investing  By: Mebane Faber.   We put together a summary that highlights the key statistics from the book.  These points help illustrate the relationship between dividend yield and portfolio return.

  • Dividends and their reinvestment contribute a major portion of the stock market return.  From 1871-2011 stocks had an annualized return of 8.83%.  If you exclude dividends being reinvested that number drops to 4.13%. For example:
    • A $100 investment made in 1871 would have grown to around $29,000 by the end of 2011.
    • By reinvesting the dividend on that same $100 investment, that $29k turns into a whopping $13,955,952.
    • Dartmouth professor Kenneth French ranked U.S. stock returns from 1927-2010 based on dividend yield:
      • High yield: 11.2%
      • Low yield: 9.1%
      • No yield: 8.4%
  • Investing in the highest yielding dividend stocks outperforms the S&P 500 by over 2% a year from 1982-2011.

A word of caution now that you know how important yield is to your portfolio. Most companies in the S&P 500 have a positive net payout yield.  That’s not to say the shareholder will receive a portion if any of that payout. There are companies that are trying to dilute shareholders, and these companies are not always easy to spot. Half of the 95 companies with a negative payout yield actually had positive dividends (12 with a yield over 3%).

  • Taking those precautions into consideration, investors should look into all the ways that companies can return cash to shareholders. Here is a simple formula to follow:
    • Shareholder yield = dividend yield + net buyback yield + net debt pay down yield
    • Due to tax treatment, as well as structural changes in the 80’s, U.S. companies have started to put the brakes on dividend payouts and started to add more stock buy backs.
      • Pre- 1982 it was considered stock manipulation for a company to buy back shares of its own stock.
      • Post- 1982 stock buy backs have become more common than dividends, as a way for companies to essentially reinvest in themselves.
      • Warren Buffet cited the importance and incentive of buy backs in his 1984 quote, “When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.” It comes as no surprise that when Berkshire Hathaway announced their first buyback program in 2011 they said the “repurchase program is expected to continue indefinitely.”
  • Hypothetical example:
    • Maximizing shareholder yield (dividend yield, net buyback yield, and net debt pay down yield) results in substantial increase in absolute returns. The simple shareholder yield portfolio outperformed the S&P 500 by over four percentage points a year. While a $100,000 portfolio invested in the S&P 500 in 1982 would have grown to $2.3 million by the end of 2011, the shareholder yield portfolio would have been worth $6.7 million.



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