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 (AXP)
AT&T (T)
Bethlehem Steel (BS)
Boeing Company (BA)
Chevron (CVX)
Coca-Cola (KO)
Du Pont
Eastman Kodak Company (EK)
Exxon Corporation (XOM)
General Electric (GE)
General Motors Corporation (GM)
Goodyear (GT)
International Business Machines (IBM)
International Paper Company (IP)
McDonald’s Corporation (MCD)
Merck & Company, Inc. (MRK)
Minnesota Mining & Mfg
Navistar International Corp. (NAV)
Philip Morris Companies (PM)
Procter & Gamble Company (PG)
Sears Roebuck & Company (SHLD)
Texaco Incorporated
Union Carbide
United Technologies Corporation (UTX)
USX Corporation
Westinghouse Electric
Woolworths

Bethlehem Steel, which went out of business in 2001, and Navistar 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 is some information about 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. Today, the Aluminum Company of America is called Alcoa (AA).
• 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. Altria was recently taken out of the DJIA along with Honeywell.
• Texaco, an oil company, was bought by Chevron 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.
• Woolworths 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, and one does not. I found it a bit confusing, as to which was AT&T, and what the available financial data was actually referencing. 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).

In light of the above, remember that actual returns would have been greater. In addition, 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).

However, 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 Woolworths 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 that can be drawn from this story:

1. 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.
2. 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. These days, there are several financials in the Dow, and 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 (BAC) $21.67
CITIGROUP INC. $16.19
CATERPILLAR INC. (CAT) $69.81
CHEVRON CORP $92.25
DU PONT E I DE NEM $41.47
WALT DISNEY-DISNEY C (DIS) $29.20
GEN ELECTRIC CO $27.66
GEN MOTORS $9.92
HOME DEPOT INC (HD) $21.58
HEWLETT PACKARD CO. (HPQ) $41.59
INTL BUSINESS MACH $122.12
INTEL CP $20.64
JOHNSON AND JOHNS DC (JNJ) $66.26
JP MORGAN CHASE CO (JPM) $33.16
COCA COLA CO THE $50.27
MCDONALDS CP $57.32
3M COMPANY $68.72
MERCK CO INC. $36.75
MICROSOFT CP (MSFT) $25.25
PFIZER INC. (PFE) $17.81
PROCTER GAMBLE CO. (PG) $63.45
AT&T INC. $32.58
UNITED TECH $60.69
VERIZON COMMUN (VZ) $34.92
WAL MART STORES (WMT) $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

Disclosure: None

Comments

[Dividend Growth Investor]

Interesting analysis. You might also reference one of Jeremy Siegel's research papers where he found out that buying the orginial 500 stocks of the S&P 500 back in 1957 and then doing absolutely nothing for 50 years would have also outperformed the S&P 500 index by 1 percentage point!

[Alex Garcia]

Its funny to see some of those names up there. Its amazing how quick things change. Eastman Kodak for example used to be an icon but is now struggling.

[Emerald]

Your analysis is worth noting. However, buying this new list near the bottom of the market will surely produce significant gains over the next ten years without any trading.

[BlueOkie]

430% for 10years. Let's see isn't that 4% a year? What happens if you have reinvested your dividends thru a DRIP? If you had only selection critieria for picking a stock, companies that increase dividends over a long period of time (10 years or more). Google Dividend Aristocrats.

[George Edwards]

This analysis is further proof, if any were needed, of the wisdom of buying solid companies and planning to hold them for a long time. A refinement of the technique would have been to assume all stocks had DRIPS plans, and you opted for them, which would have been the best pre-retirement strategy.

Mind you, not all of the DJIA stocks meet my personal quality criteria, so I would have been more selective. The same holds true today, for example GM. And there are other higher-quality stocks which are not on the DJIA list. Quality is the issue, and dividends are part of the definition of quality.

[mariposa]

And you could pay attention, and sell if the future didn't look good for the company. You could also dividend reinvest in the company, or invest the dividends elsewhere. Your return would certainly be better.
When times are rough, like now, for the most part I hold the dividend payers, and sell those that don't. The ones bought for fast growth are usually not growing and the more stolid ones lose less, and they pay the dividend while you wait for better times.

[SkipinCA]

A couple of comments:
1. Mr Okie - I believe your math is a little off this morining. Generating a 430% gain over ten years is NOT equal to 4% annually. If you got 4% annually on $100 for 10 years you would have $40, assuming no compounding. Using a HP17B calculator to compute the future value of $100 compounding annually at 4% you would have a future value of $148. (n=10, i=4%,pv=-100, pmt=0).

To get a FV of 430% of your initial investment, your IRR would be 15.7%, not 4%. That is a very good return, especially considering that it is exclusive of dividend reinvestment. (n=10, pv=-100, pmt=0, fv=430)

2. GM should be deleted from the list. They just announced a suspension of their dividend.

It is getting bad out there!

[sharksm]

One comment worth considering. I purchased 1,000 shares of MO over 28 years ago and re-invested the dividends for over 20 years until I had amassed 20,000 shares (including splits). At the current time, I hold 20,000 MO, 20,000 PM and 10,000 KFT (I sold about 3,000). My current income from this original investment is over $70,000 a year, twice what I paid for the original Investment. I also have long time positions in other blue chip companies that have multiplied many times from my original investment.

[flstearns]

A great read on a Tuesday morning when we are listening to BB explaining the flailing world to us via C-SPAN. I'm going to look at the current DJIND list now, asking "What's prospects?"

[Ken D]

First, interesting to see that names of companies like Westinghouse, Philip Morris, and Union Carbide had to be explained. Sheesh, I guess I am getting old, as these are as familiar as Google to me. More directly, I sometimes wonder "what is the true value of a stock." As the market value varies so greatly, the "present value of future cash flows." people surely must think that cash flow is not too clear! Dividends really help me see the value -- compared with bonds or most treasuries these company payouts provide real inflation protection. Thanks for an article weighted to something other than tomorrow!

[quick]

What about PGF: the PowerShares Financial Preferred ETF? This thing yields about 8% and is only down about 1.2% ytd, compared to -30% or so for XLF. I just discovered it today and I'm looking into it for my IRA, if anyone has any opinions on PGF, please feel free to share.

[Shane99]

quick..be careful. You are probably walking into a value trap, with many of the that ETFs holdings cutting their dividends.

[sunrises]

Hello,

Is USX corp. (X) expected to have volatility on the upside soon?

[jobu7777]

Okie and anon: I think the reference to 430% is to a 20-year return not a ten year return, which comes out on my HP12c as about 8.7% annually...

[Tenbern]

Good info, thanks

[Ganesh Kumar]

Interesting analysis. I would also like to know how you would have faired if you reinvested the dividends. Also if the analysis can distinguish between companies that raise the dividends consistently and the ones that do not.