Capital gains get all the hype, but dividends may be a better solution to grow your portfolio. This past weekend I watched an episode of Wealthtrack in which host Consuelo Mack interviewed Hersh Cohen about his long-term investing success based on ownership of companies that consistently grow their dividends. Dividend-growing companies are generally more attractive investments, and their less volatile nature may prevent individual investors from beating themselves by succumbing to reactionary forces in response to market swings.
From 1/31/1987 to 12/31/2016, dividend growers returned, on average, 13.8% with lower volatility (14.5%) while dividend paying companies that do not increase their dividend returned 10.1% with 17% volatility and companies that do not pay dividends 7.4% with 24.3% volatility.
Cohen discussed why he is constantly looking for the next dividend aristocrat. First, business managers who are committed to returning capital to shareholders have less capital to allocate to ill-timed share repurchases and material acquisitions of unrelated businesses. Capital allocation is challenging, even for the highly-talented executives. Cohen believes shareholders should focus on capital allocation and business managers should focus on operations.
Most importantly, Cohen’s dividend growth approach is designed to help investors, professional or novice, maintain their investments during down periods of the market cycle. As stock prices fall and interest rates are pared to stimulate economic growth, dividend-paying stocks will be buoyed, in a sea of sinking share prices, by investors searching for income. Moreover, dividend growers are particularly beneficial, said Cohen, because, in tough times, consistent income growth from dividend-growing companies will compensate for stagnant wages. During periods of significant market turmoil, the less volatile nature of dividend growers will mitigate shareholders’ fight or flight response.
Cohen’s dividend-growth approach also prepares a portfolio for future market volatility. Dividend payments act as a countervailing force to elevated asset valuations because, as market multiples expand, dividends grow a portfolio’s cash balance and reduce the relative amount of capital exposed to an extended market. During a market downturn, as cash in hand accumulates relative to the portion of the overall portfolio. By rebalancing to target weights of equities and cash, Cohen and like-minded investors systematically buy stocks at discount prices.
My Take
Do not be confused; past dividend growth does not ensure consistent future dividend growth; Cohen said he wants to own stocks that will be dividend aristocrats thirty years from now. Moreover, Berkshire Hathaway is one of Cohen’s largest positions, despite its policy to not pay a dividend, because he trusts Berkshire’s ability to allocate capital. The spirit of Cohen’s approach, not the letter, is important.
The most valuable lessons reinforced by this episode were related to dividend growers’ power of simplifying portfolio management and achieving better results for shareholders. Dividend growers stabilize portfolios through the nature of their share price stability and by simplifying the rebalancing process (by growing the portfolio’s cash balance). Though investors may lust for soaring prices of growth stocks, a more measured approach is much easier to maintain as market levels retreat. Cohen’s may be a less thrilling approach, but an individual’s ability to time the market is less important than his or her time invested in the market. Private investors tend significantly underperform the market (and even underperform the funds in which they invest) as they chase returns when buying at market peaks and clamoring for the exit as markets dive.
As Cohen recommends, investors should study history to prepare for the mental turmoil of market downturns. Investors should also consider the history of investor behavior during recessions and adopt an approach to avoid common mistakes. Two parlay, two paraphrased Warren Buffett quotes, temperament is more important than an investor’s intelligence because you have to maintain market positions through tumultuous periods for the market to find success as an investor. If you lack nerves of steel, you would be wise to mitigate the volatility of your portfolio because an ounce of prevention is worth a pound of cure.