The Dividend Mailbox

When Challenges Arise, the Better Investment Isn't Always Obvious

October 21, 2022 Greg Denewiler Season 1 Episode 16
The Dividend Mailbox
When Challenges Arise, the Better Investment Isn't Always Obvious
Show Notes Transcript

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It's safe to say that the stock market faces some daunting problems currently. To some investors, it's enough to make them change their strategy, seek alternate investments, or pull out entirely. Regardless of the negative consequences those actions can have on your portfolio, haven't investors always faced challenges? As Morgan Housel brilliantly states:  "Every past market decline looks like an opportunity, and every future decline appears to be a risk." 

Understandably, if you were to listen to all the noise out there, it'd be hard to look past your nose. That is why in environments like this, one of the best things you can do is take a step back and gain some perspective.  

In this episode, Greg shares a couple of reassuring stories that illustrate how important it is to stay the course. In fact, if you stay on track long enough, it could result in immense wealth. He examines how a rental property investment might perform decently well, but falls short in comparison to dividend growth. Later he takes a look at NASA's recent D.A.R.T. mission success, drawing a comparison to long-term investing.

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Greg – 00:10

This is Greg Denewiler, and you are listening to another episode of The Dividend Mailbox, a podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks and make each year's check larger than the last.

 

Welcome again to episode 16 of The Dividend Mailbox. In this episode, I'm going to tell you a couple of stories, and I hope what you get from them is just how important it is to stay the course. Because especially as you know, in today's environment, it gets very easy to get distracted. So what we're going to do is kind of look at just how important it is to stay on track.

 

So, to start, let me take you back to Middle America, 1961. If you had the skill and the time, you could build a three-bedroom house, two bathrooms, two car garage on a half an acre lot for $12,000. Well, going through some papers that came from my parents' house, in there was the original mortgage of the house they built, and the payment was $75.23 a month. So right away I begin to wonder what a great opportunity if I could do that again. And immediately you connect the dots between what rates were then and what it costs to buy a house then, to what they're worth today. It seems like, boy, I wish I sure would've bought a lot more houses back then. Of course, I was only four years old, that's beside the point. But what the numbers don't tell you is what was the actual return and what were the alternatives? Was it really a good investment? That, you don't know, until you start to look at it. So that led me to start thinking about, okay, what happened over that period of time? Interestingly enough, the environment in 1961 was very similar to what it is today. You had 10-year treasuries at 4%, virtually the same level they were then. Mortgage rates on a 20-year mortgage are around 6%, that's what they were then. Inflation was 3.8%, which is lower than the numbers currently, but back then inflation was heading higher, and it stayed higher for a long time. So, the theme was in 61, inflation, and the theme today is definitely still inflation. But let's just assume in 1961, an investor has cash, and they want to buy a rental property. So, they buy a house for $12,000. If you go back historically and even today, houses rent for between 8- 9% a year of their value on an annualized basis, so you would've rented the house for probably about $900 annually. Through insider information, I happen to know that the house rents for $11,900 currently, so that implies that the rent grew by 4.3% a year for the period of 61 years. Of course, the rent didn't go up by exactly 4.3% a year, but that was the annual compounding value. So, when you first look at the numbers, annual rent of $900 growing to $12,000 is a pretty phenomenal increase, it's more than 10 times. The compounded value of the rent would've paid you a total of $265,000 over that 61-year period. That doesn't even account for the value of the house and what has happened there. If you look at Zillow, the house is $160,000, so that's a gain of $148,000, which is way more than 10 times. That translates into a total value, including the rental income, of $425,000. That's a 6% annualized total return. It looks like it's a very attractive investment, and the immediate reaction from most people is, "I'll take some of that." But one thing that the rental property, in this example, does not include is that the house took three roofs. You had to repaint it numerous times, and there were miscellaneous expenses. The actual house in this example was built by my father in 1961, and it's what I grew up in, and now my sister and I rent the house out. So, it is an example that is a real life situation. 

 

Well, the investor in 1961 had another option, they could have just invested in Blue Chip America. And in September of 1961, the S & P 500, was trading at a value of $67. The dividend was a $1.96 at that point, so you could have bought 180 shares and that would equated to roughly $12,000. That generated $360 of income. If you own the house as an investor and were collecting the rent, $900 is a much bigger number than $360, so most people would jump for the rental. And in this case, where the dividend grew from a $1.96 to $65, currently, that's 5.9% annually. Obviously, that's a faster growth rate, but when you look at the actual return that you've got on the dividend today, that's $11,700 of income. Well on the surface, that number's still smaller than the $11,900 that you're getting from the rental. You never received as much dividend income as you did rental income, and it took a long time to catch up. But here is the part where people trip up, or why they underestimate the power of dividends: it's that growth rate and how that gets factored into prices over time. That's what starts to make all the difference. Instead of the rent that grew at 4.3%, your dividend grew at 5.9%. That is going to also translate into the price of your 180 shares. The index, as I'm recording this podcast, is 3,580. If you take your 180 shares, you've got a total value of $644,000, and over that period, you would've received total dividends of $204,000 without compounding. So, the total value of your initial $12,000 investment is now $848,000. Just looking at simple growth, you more than double what the investment would've been in the rental property. So, we used simple arithmetic to add up the rental and the S & P 500 income to keep them on an equal basis. The rental property had a total return of 6% a year, the S & P 500 had a total return of 7.3% a year. But now let's go one step farther, because you can't reinvest in a house every time you get a rental check into another small portion of a house. But what you can compound are the dividends coming from the S & P 500. If you reinvested the dividends over that same period of time, you've now got $3.9 million... those little dividend checks do add up. Now I can imagine that some of you are thinking, " Yeah, you know, real estate in middle America, that's no great thing. I mean, what great story is that?" Well, the reality is, the trends are what really matter. And number two, just like there's individual real estate markets or specific properties that do extremely well, there's also sectors of the market and there's individual stocks that do extremely well. So, the point is, it's just looking at the overall concept and the trends. 

 

But why look at a mortgage that was a $75 payment in 1961? Because when you first look at it and compare it to today, the numbers look very appealing to what's going on in the world. On the surface, it looks like a $12,000 rental check, it's a whole lot easier to just take that than it is to look at the current market and say, how are they going to solve all these problems? We've got a war with Russia, that we know. We have inflation, we don't know how that's going to work out.  We may have a nuclear war. There's just a lot of problems out there that we don't know the answer to, so it makes you gravitate towards what you feel is more kind of right in front of you, and it's much easier to quantify cashing that rent check. However, one of the problems- and it's not just with investing, it's really in virtually life itself- when you look back historically, you tend to just more remember the good things, but the reality is things weren't that much different in 1961 than they are today. 10-year treasury rates are almost identical, and interest rates were going to get as high as 18% by the time you got to 1981. The market, the S & P 500 in 1961 had a PE of 22. We started in 2022 with the S & P trading at 24 times earnings, which was roughly the same level, slightly higher, but now with the market coming down, we're only at 17 times earnings. The market is actually priced a little cheaper than it was in 1960. Well, again, you're probably thinking, "Yeah, but times were different there, life was simpler, and if I could go back there, wouldn't it be great, but we've got a lot of problems right now." Well, let's go back and just look at some of the things that happened over that 60-year period.

 

In October of 1962, we had the Cuban Missile Crisis. That was a period where we got very close to a potential nuclear war. Some people say that it was maybe within just a few discussions, and I can remember in elementary school where we had to get under our desk because we had a bomb drill. You know, what in the world difference would that have made? But it is what it was. You may also remember protests. We had race riots in the 1960s. We had the Vietnam War. Again, we had the 70s inflation period where the market basically didn't move. The price of the S & P 500 was relatively flat, the only return really came through dividends. We had eight recessions over that period. By 2008, we had a significant global financial crisis that was considered to be one of the worst recessions since the depression. And then by 2020, we had a pandemic almost completely shut down the economy for a period of time. 

 

So, here's the dilemma that investors really almost always face. If you take yourself back to 1961, if you knew the news ahead of time, all the problems that came up, all the challenges that occurred over the next 61 years, you probably would not have invested in the S & P 500. Especially when you took a rent check at that point, that was almost a $1000 a year versus the dividend income of $360. It's probably almost a layup- just take the rent. But the reality was it was a whole lot better to just invest in the S & P 500. Your return, as we've illustrated, has been just much higher. Most of the time, if you knew the news ahead of time, what you don't know is how investors are going to react. And a lot of times it's almost to your detriment, knowing what's going to happen in the future. It's the same situation today. It really never goes away. It's always like this, and it becomes very easy to just get lost in the news, to get caught up in what people are worried about for the next three months.

 

Morgan Housel has a quote: "Every market decline in the past looks like an opportunity, and every market decline in the future looks like a risk." So if you think things are bad, just remember as a long term investor, opportunities are what you want. They're your friend as an investor. In the latest edition of Barons, the October 17th edition, Nicholas Jasinski says: "A further cut in the 'E' of 'P/E’ would make stocks look pricier, discouraging potential buyers." Well, that right there tells you that things are maybe going to get worse before they get better. Current earnings estimates are $208, that's why the PE on the market right now is 17, which is very close to the hundred year average. But here's one thing that I want to make sure that you get the point. If you have that rental house and that rental house has sit vacant for six months, and you've decided that you want to sell it because you want to do something else with the money, are you going to look at that rental property and say, "Hmm, I haven't gotten rent for six months, so my rental income for the year is half, so I think I'll just sell that house for 50% less." That's not what you would do. I can tell you what you would do is you would normalize it. Here's the rent you're going to get year in and year out, that number is a lot higher than what it is right now. But the funny thing is that's what investors seem to do with just these short-term movements. And one thing that you really need to keep in mind is that over time earnings go higher. It's almost a 100% guarantee, it's just a matter of how long it takes. And historically, it's been about a few years and usually the earnings of the S & P 500 have recovered and started to make new highs. 

 

As a way to think about dividend growth, take three scenarios over a decade period. And let's just say each of these scenarios, the market ends up at the same point. In scenario number one, the market goes down and stays down for most of the decade, and then rallies at the end and you're reinvesting. The second scenario is: market just goes up 9% a year, and it does that for the entire 10-year period. Scenario number three is the market goes up for a few years, then the market goes down for a few years, and ultimately the market ends up higher. Well, my question to you is, which scenario do you want here? Again, most people when they just look at it from the surface, "well, I'd rather just have 9% a year." But the scenario you really want is the market to go down for nine and a half years as you continue to reinvest those dividends at much lower price, (which is also called opportunity), and in the last six months, then you want the market to go higher because you're going to earn a lot more money through the reinvestment when prices are much lower. So today there are a lot of challenges, but the thing about investing is there always are, but with the market basically at its long-term valuation of 17, now is just as good a time as any to get on the line and stay on the line- that 6% dividend and growth over time.

 

When it appears to look like things just aren't going to get a whole lot better in the near-term future, I'd like to leave you with a story that I think really illustrates don't underestimate America. Embedded in it, as I will illustrate here in a minute, is really the exact same concept for investing. So last year NASA launched a probe on a one-year mission trying to hit an asteroid millions of miles away, that's only 500 feet wide, and the asteroid's name was Dimorphos. Now Dimorphous orbits a larger asteroid every 12 hours, and the larger asteroid orbits the sun every 770 days. So to call this a moving target, I think is an understatement. The probe was moving at 14,000 miles per hour when it finally did hit the asteroid. So you've got something that was launched, was only a little more than 1200 pounds, traveled for a year at an extremely high rate of speed, and hit a target a little over 500 feet wide. It just almost seems incredible. And not only did it basically hit exactly where it was supposed to, the probe actually changed the orbit by 13 minutes. Even NASA was not sure whether it was going to be successful. NASA was just hoping for seconds, and they actually got minutes. Basically, the reason why they did this was if an asteroid is potentially on a collision course with Earth, they want to try to figure out whether they can actually change the orbits of these asteroids. And in fact, it worked. So in 1961, we're trying to put a man on the moon and we actually did. In 2022, we're trying to hit an asteroid millions of miles away, that's only 500 feet wide. Well, we actually did. The moral of this story, I think is, don't underestimate America. It's incredible what technology and research and what's out there that we don't even know that can change over time. And again, corporate America is always adapting. 

 

It's easy for people to visualize a house, to visualize a renter because they can actually see it. They can drive by and they see the checks coming in, and when the checks are bigger from the beginning, it definitely makes it easier to think: "Hey, this is going to work out and it's going to be a profitable venture." I think it's a little harder when you look at investing. It's a lot like trying to hit an asteroid, that's a long, long ways away. 

 

The first takeaway: you first have to believe. You have to start the process. You know, when NASA looked at the project, they had to spend $350 million, and they had to believe that the mission had a purpose. And the one thing that they did not know was\ whether it was even going to be successful. 

 

Two, you have to stay the course. When you're trying to hit a very small target, that's a long way away. You have to stay the course from day one. You cannot deviate. I think it's sort of the same thing in investing. You can't listen to the noise, and you can't miss one of these big rebounds and they almost always happen when markets are experiencing a prolonged downturn. They come when you least expect them and when the news is still bad. 

 

Number three, small beginnings can have dramatic outcomes over enough time. If you look at the probe that was sent, it was 1200 pounds. It ends up moving a megaton rock. So, who would've thought that 1200 pounds could do the job? Well, it's kind of the same sense in 1961. Is $12,000, a onetime investment, enough to turn into $3.9 million. It takes a belief, and it takes discipline; small dividend checks can have big results. 

 

Number four, how many things could have gone wrong to prevent that probe from missing its target? And just like in 1961, there were a lot of things that could go wrong to prevent that $12,000 from hitting $3.9 million. But in the end, even after eight recessions, a war, politics, a pandemic, etc., the target was still hit. 

 

So it's easy to cash rent checks and it's easy to cash dividend checks. However, you have to believe that cashing a smaller dividend check is going to lead to a much greater outcome over time, because in the end, it's the compounding and it's the higher growth rate that makes all the difference.

 

It's sort of like NASA could have saved Earth if Dimorphos was actually on a path heading to Earth. And it only took a 13-minute orbit change and the job would've been done, because it was far enough out and it had enough time to make a big enough difference. Dividend checks in the same manner, given enough time, can change your retirement lifestyle.

 

If you enjoy today's podcast, please leave us a review and follow us on LinkedIn, Instagram, and Facebook. If you would like more information regarding dividend growth, or just our style of investing, go to growmydollar.com. There you will find some of our previous podcasts and also our monthly newsletter. If you have any questions or anything to add regarding today's podcast, email ethan@growmydollar.com.

 

Past performance does not guarantee future results. Each investor should consider whether a strategy is right for them and all the risk involved. Dividend stocks are volatile and can lose money.