Checklists seem able to defend anyone, even the experienced, against failure in many more tasks than we realized. They provide a kind of cognitive net. They catch mental flaws inherent in all of us—flaws of memory and attention and thoroughness. And because they do, they raise wide, unexpected possibilities.
― Atul Gawande, The Checklist Manifesto: How to Get Things Right
Show me the money!
-- Ron Tidwell, Jerry Maguire
Everybody likes getting paid - we’re all a little bit ‘Ron Tidwell’. That’s why so many of us search for stocks with dividends. There are many academic arguments in favour of consistent payments to shareholders: they don’t just provide a (relatively) reliable return - they can also cushion capital losses, reduce portfolio volatility, and provide a handy reference point for valuation.
The most intuitive pro-dividend argument is the ‘bird in the hand’ theory, which says dividends today are more valuable to some investors than less certain capital gains tomorrow. This thinking goes as far back as Benjamin Graham who, in an updated version of his book Security Analysis, wrote that ‘the typical dollar of reinvestment has less economic value to the shareholder than a dollar paid in dividends.’ If this is true, then it follows that a dividend-paying stock should trade at a premium to an identical company that does not pay a dividend.
What’s more, the compounding effects of reinvested dividends can be a powerful force for an investor. The contribution of dividends to total stock returns - the measure used in most academic studies that form the basis of successful real-world strategies - is formidable.
Some assorted illustrations from various sources:
The total compound annual return for the S&P 500 Index with dividends reinvested from the beginning of 1926 to the end of 2015 was between 9 - 10% as compared with 5.8% on the basis of price alone (source: CFA).
Similarly, from 1950 to 2015 the Nikkei 225 Index returned 8.3% compounded annually based on price, but 11.5% with dividends reinvested (source: CFA).
Schroders/Cazenove data shows that, from the end of 1999 to the end of 2018, the FTSE 100 would have generated an annual return of 3.54% with dividends reinvested, compared with -0.04% if you had invested in just the index.
Antti Ilmanen in his 2011 book Expected Returns: An Investor's Guide to Harvesting Market Rewards found that, from 1900 to 2009,…
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