The Dividend Yield and Stock Price Connection

Buying for the dividend, in the long term, is also buying for the stock price.

Fads dominate financial magazines.  A quick survey of current editions will often show recommendations of hot stocks and successful mutual funds to purchase right now.  Of course, this year’s successful mutual fund manager may not have this success last into the next year.

The magazine’s stress is on immediacy, which makes complete sense for them.  After all, they need to sell the magazine and next month they will again need to do the same.  Long term purchases are boring and by definition do not need to be changed every month, and that does not sell magazines.

The extreme fad would be day trading.  This has nothing to do with investing and is very stressful.  With immediacy paramount, stocks are purchased and held for mere days or even minutes.  Even if one is able to turn a profit (unlikely, as a study of day traders in Taiwan showed that 80% lose money), the amount of work in simply reporting the transactions to the IRS must be very time-consuming.

The investor’s chief problem – and even his worst enemy – is likely to be himself. – Benjamin Graham

For the long term investor the opposite exists.  Whereas day traders only consider factors for the very short term, dividends are important to the long term investor.  One might think that the stock’s value is the only important issue at hand, but ignoring the importance of the dividend is a real mistake.

As an example, $10,000 invested in the S&P 500 in December 1960 would have yielded a value of about $430,000 – not a bad return on investment.  However, the total return including reinvested dividends would have been almost $2,500,000, more than five times greater.

This shows that not only is it worthwhile to reinvest dividends, but hints that there may be a linkage between price and dividend growth, and indeed this is the case.

The dividend can act as the proverbial canary in a coal mine as far as understanding the health of the company is concerned.  After all, the dividend is real money.  Regardless any accounting tricks that can be employed to obfuscate or deflect accounting numbers in the quarterly report, hard cold cash cannot be denied.

A continually rising dividend rate is a reflection of the fact that the company can at least pay that money to their shareholders.  Companies can only increase dividends when they know that future cash payments will be sustainable.  Companies that cut or suspend their dividend are offering a tell that the future of the company may not be as rosy as they let on to be.

The linkage between a growing dividend and rising stock price not only makes sense, but research bears this out, showing a correlation of close to 90% over 25 year cycles.  So as the dividend grows, the price of the stock is more than likely to move in the same direction.

It is amazing that this is a fact that tends to get lost.  Looking for the next stock tip and hoping to find a clue that will allow one to buy low is a common goal for investors.  However, for those looking to advance over a long period of time, it could be that finding the safety of a dividend is the best long term bet.

This underscores the significance of the Dividend Champions List as a great starting point for finding a company in which to invest.

The Best Of All Worlds

Finding fee-free DRiPs and companies with a long history of increasing their dividend is a great place to start when researching additions to a DRiP portfolio.

Dividend Reinvestment Programs (DRiPs) offer numerous advantages to the investor who is seeking to build wealth over a long period of time with a minimum amount of risk.  This is done by selecting great companies and then making regular purchases.  While others stress about the ups and downs of the market, the DRiPper understands that when the market drops those regular purchases will obtain more shares.

As noted in the last article, when fees impinge upon those purchases it can put one in a position where it may not make sense to invest.  The good news is that there are hundreds of companies that offer fee-free purchases.  These include AFLAC, Johnson & Johnson, MMM, Aqua America and Exxon, which are the companies in my DRiP portfolio.

It could take a lot of research to figure out which companies offer fee-free DRiPs but DirectInvesting.com maintains such a list.  DirectInvesting.com is a company I have used over the years to purchase that first share and start my DRiP.  I have also taken the route of finding a less expensive means of doing this but there is value to saving time and enjoying convenience, so it’s up to you to decide which route to take.

One of the knocks about purchasing dividend stocks is that the dividend may get cut or even eliminated.  Without question, this is something that should be taken into account.  If one purchases a company because the dividend offers risk mitigation and that safety net goes away, then the reason for holding the stock may also go away.  This is not good for a long term strategy where risk is a consideration.

Many years ago I met Dave Fish, who was one of the initial moderators at DRiPInvesting.org when I created the website in 2002.  He maintained a list of what he called Dividend Champions (as well as Contenders and Challengers) and I started posting that list every month because I felt that it was so important.

Dividend Champions are companies that have increased their dividend every year over at least the past 25 years.  Of course nothing is guaranteed going into the future, but when I think about a company that continued to increase its dividend every year during the fall of the internet stocks at the beginning of the century, as well as through the financial crisis that began in 2008, I know that that is a company committed to their dividend.

Included in the list of Dividend Champions are Contenders (companies that have increased their dividend every year for 10-24 years) and Challengers (companies that have increased their dividend every year for 5-9 years).

When Dave Fish passed away the list was taken over by Justin Law, who updates it on a monthly basis and uploads it to the Information, Tools, And Forms page at DRiPInvesting.org.

Combining the two lists to find the intersection of companies with fee-free DRiPs that have increased their dividend for at least 25 years is an essential starting point for anyone wishing to find a company that might offer stable dividends going into the far future.

Dividend Champions With Fee-Free DRiPs (November 2019)

3M Company
AFLAC Incorporated
Albemarle Corp.
American States Water
Aqua America Inc.
Arrow Financial Corp.
Artesian Resources Corp. A
Black Hills Corp.
Brady Corp.
California Water Service Group
Carlisle Companies Inc.
Chubb Limited
Cincinnati Financial Corp.
Community Bank System, Inc.
Donaldson Company Inc.
Ecolab Inc.
Emerson Electric Co.
Exxon Mobil Corp.
F&M Bank Corp.
Federal Realty Investment Trust
Hormel Foods Corp.
Illinois Tool Works Inc.
Johnson & Johnson
Lancaster Colony Corp.
MDU Resources Group Inc.
Middlesex Water Company
National Fuel Gas Co.
Nucor Corp.
Parker-Hannifin Corporation
Realty Income Corp.
RLI Corp.
S&P Global Inc.
Sherwin-Williams Co.
Telephone & Data Systems Inc.
Tompkins Financial Corp.
UGI Corp.
UMB Financial Corp.
United Bankshares, Inc.
Universal Corp.
Universal Health Realty Income Trust
West Pharmaceutical Services Inc.

What Is A DRiP?

Dividend Reinvestment Programs allow one to easily build their position in a company by automatically reinvesting dividends.

Many of us go through a phase where we understand how stocks work, we understand some of the factors that contribute to the increase or decrease of the stock’s price, and therefore feel that we can anticipate these changes and start trying to time the market.  In the late 1990s we were all geniuses and in the early 2000s we were all idiots.

I started investing in Dividend Reinvestment Programs in the early 1990s and a decade later came to realize that although I survived the fall of the Internet stocks in the early 2000s, simply finding great companies and making regular investments probably would have been the more lucrative route.

Companies that offer dividends know that it is to their advantage to retain their investors.  This is one reason they might offer a Dividend Reinvestment Program. A Dividend Reinvestment Program is one where purchases of stock can be made without going through a broker, and the dividend one receives is used to purchase the company’s stock.  For example, instead of receiving a $10 dividend check, one would have that $10 used to automatically purchase as much stock as that amount would represent.

This normally results in one owning partial shares.  For instance, MMM’s current stock price is $170.09.  Instead of receiving a $10 dividend check, one would have 0.058 shares (10 / $170.09) added to their holding.

At first glance this does not seem like much, and indeed it is not.  Looking at my purchase history of MMM I see numerous dividends being converted to partial shares in this range.  I did make somewhat regular purchases through the years but today a bit over 30% of my holdings of MMM were obtained through the reinvestment of dividends.

It should be noted that some companies are charging for this service.  At one point I had a DRiP set up with The Coca-Cola Company.  I would send a check for $50 which was used to purchase $50 of stock, and my dividends were converted to stock without charge.  I no longer own shares in the company partially because they decided to start adding fees to the DRiP.

Computershare administers KO’s DRiP and below are the charges from their website.

Initial setup $10.00
Check $3.00
Per share processing (check) $0.03
One Time Investment $3.00
Recurring $2.00
Per share processing $0.03
Dividend reinvestments 5% $2.00 max
Batch sales processing (per share) $0.12
Market order sales $25.00
Market order processing (per share) $0.12

This hardly makes it worthwhile to participate.  A $50 purchase is immediately decreased by more than 6% through fees, and reinvestments similarly have a chunk taken off the top.  This means that the values of the stock needs to rise accordingly just to get back to even.

Fortunately, there are over 200 companies that offer fee-free DRiPs, meaning that you pay to have things set up and you pay to sell shares, but purchases and reinvestment are without cost.

In the next article I will delve into what I see as the first step in selecting companies that will offer you dividends for decades to come.

What Is A Dividend?

Before any discussion of dividends can begin, we need to understand dividends and how they work.

One of my ancestors was Asa Griggs Candler. That name may mean little to you unless you live in Atlanta, Georgia, where the last name is everywhere. In 1888 Asa purchased the Coca-Cola formula for $2,300. He had a flair for marketing and very quickly built the company to the point where he would sell it about 30 years later for $25,000,000.

Owning a company is a way to make money, but few of us have the means and/or talent to do so. An option is to find a company in which we see potential and make an investment in it. Purchasing shares in a company makes us part owners of the company, though a very small part of the company.

To understand how small that share might be, consider that Warren Buffett owns 400,000,000 shares of Coca-Cola, and that represents less than 10% of the whole company.

Nonetheless, when the company does well and is considered to be more valuable than when one make their purchase, the value of the stock rises. If we sell our shares at that point then we have made a profit. Similarly, if the company is less appreciated the value of the shares decline.

There is another way to reward owners of the company than to have its stock price increase, and that is through dividends. A dividend is a payment by the company to its owners and is a way of sharing the company’s wealth.

For instance, if one owns 100 shares of a company and that company decides to give $1 per share to its owners then one would receive $100. Although companies differ, those that offer dividends to their owners most often do so on a quarterly basis. This allows the investor to benefit from the company’s success on an incremental basis.

Each quarter the company’s board of directors meets to determine the amount of the dividend (for those companies that offer a dividend). Once the decision has been made the amount is announced, along with the date on which it will be paid and the ex-dividend date.

The ex-dividend date is the date on which one must own the stock to be eligible to receive the dividend. The number of shares owned on the ex-dividend date will be the basis on how much one will receive, even if the stock is sold after that date.

Most investors make their purchases through a brokerage account, so that dividend gets sent to the broker. Stock that is held within a mutual fund has its dividend added to the holdings of the fund.

Instead of receiving the dividend as cash, it is possible to have the equivalent converted to stock. I currently own companies where more than a third of my number of shares were purchased through the dividend. This is done through a Dividend Reinvestment Program, or DRiP, and will be the subject of the next article.