Putting together everything we've learned so far, we make the case that not only is 6% dividend growth attainable, but it can be reasonably expected in a variety of market environments. Stay tuned for a Q&A segment that goes deeper into the ins and outs of the dividend growth strategy.
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Greg Denewiler 0:11
This is Greg Denweiler, and you're 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.
Greg Denewiler 0:37
Before we examine the question of: "can dividends grow by 6% over the next decade?" Let's go back and look at what we've covered so far. First, we've looked at long term returns for the market. That number has been about 9-10%. The dividend yield, even though it's only been about 2.5-3% in the last several decades, due to compounding, it has brought the return up to almost half. We've looked at the 400 of the 500 stocks in the S&P 500 pay dividends. Most of the market is a dividend stock anyway, so it really doesn't limit your scope of where you can invest. Then we also looked at compounding, and we looked at the penny story. And the illustration of that is if you add compounding over time, it's really the second and it's the third decade, which is where it really kicks in and makes a huge difference in your returns. We also looked at one of the best performing well- actually the best performing- stock in the last 50 years was not a price growth story. It was a dividend story and that was Philip Morris. It wasn't Amazon, it wasn't Apple Computer. It wasn't some high tech or big startup. It wasn't even Tesla. Well, one of the reasons why Philip Morris was so successful was because the dividend has been extremely attractive really for the past 50 years, because nobody wanted to own tobacco. So, you were able to continually reinvest that dividend at a cheap stock price because tobacco has been out of favor.
Greg Denewiler 2:23
Now, back to our question: "can dividends grow by 6% over the next decade?" Well, we've looked at in the past these three lines. One of them was GDP growth. One of them was EPS growth, earnings per share. And then the third line was dividend growth. And if you go back 70, 80, 100 years, long-term on an annual basis, all three of those lines pretty much grow by 6%. Well, first of all, we need to look at GDP because we have to have GDP growth if we're going to get earnings growth. About 30 to- currently I think it's around 35% of GDP is made up of government spending. That obviously is not going anywhere. So, we have kind of a built-in growth really no matter what right there. Then when you look at earnings, if GDP grows by 6%, that's going to grow earnings. Part of earnings growth is going to come through the ability of companies being able to raise their prices. You know, think about PepsiCo. PepsiCo sells Pepsi and they sell Fritos. If you go to the grocery store 10 years from now, do you think you're going to pay less for Pepsi, you're going to pay the same, or are you going to pay more? The answer is probably obvious. Will they sell more Fritos? Quite possibly. Will they sell more Pepsi? It's a global brand, it's not just the US, as you get India you get the emerging middle class in China. You can't just focus on your own neighborhood to get an idea of what the market may or may not be doing. Same thing goes with Amazon with Walmart, will they be selling more stuff in 10 years? Do you think the prices will be the same? Well, virtually nobody expects prices to go down over time. So, part of earnings growth, part of GDP growth, is just pure inflation. The problem is, I think we tend to get too short term focused on news headlines of why something isn't going so well. But you have to remember that the underlying economy has some very powerful trends that are built into it that are constantly at play. Can't lose sight of the fact that the economy sort of runs on remote control. And it's just simple allocation of capital, you know, companies making investments over time.
Greg Denewiler 4:56
Earnings growth follows GDP growth. Earnings per share growth is not as steady as GDP growth, but you still have the same 6% number. If you go back to 1988, earnings were $5.50 on the S&P 500. Now they're approaching this year- they're probably going to come in around $200. When we get into recessions, earnings are very volatile, they can, you know, they can drop by as much as half or more. And that is a piece of what happened last year, but they also recover. Well, dividends, the good news there is, that line is much more stable. We've looked at that in the past. And there this year, we're probably going to get, we're going to come in at around $60 for the dividend for the S&P 500. And right now, with $200 of earnings, that means that the dividend payout ratio is about 30%, (meaning that if a company earns $1, they're paying out 30 cents as a dividend). Here's the good news on that, historically, that number is near its low. If you go back 100 years, the payout ratio companies were paying roughly 55 cents out of every dollar, it's been trending down. But the last few decades, the average has been around 40 cents to 35 cents. So now that we're down at 30 cents, there's a little bit of margin of error there. A piece of that may be because they have been focusing some on share buybacks, and some of that capital that would maybe go to a dividend has been going to buying back shares. So even if earnings don't grow by 6% over the next decade, if the payout ratio goes up to 40%, that means that we only need 3% earnings growth. And that means that earnings would be up to about $270. Well, the good news there is the estimates for 2023 for the S&P 500 or that it's going to earn $240. So, we're getting close to that 3% growth number, if estimates end up coming in as they expect. So, it's not really that difficult to see how the 6% number can continue to hold. Again, all's we're doing is basically just looking at the trend of the market to get us where we need to be. You know, another thing that I think you got to remember, earnings growth is not a straight line, it does it does deviate a little bit. There are some decades when the when the growth rate only averages about 3% or 4%. And there are decades when the number goes up to 8%. But again, you know it is the trend line.
Greg Denewiler 7:58
Another thing that I think you have to remember which helps us get to this 6% growth number is that 400 of those 500 stocks in the S&P 500 pay dividends right now. Some of those are very small dividend payers, some of them are not growing, some of them are just high dividend payers and then you've got some also that that have cut. Because we're trying to focus on dividend growth, what we're doing is we're trying to keep the anchors out. We're just focusing on the growth side just by maintaining discipline. So, let's just look at a few examples for 10 year growth rates. Microsoft has grown its dividend in the last 10 years by 13%, Intel 7.7, Johnson and Johnson 6.6, McDonald's 8.4%, PepsiCo 7.8%, Lockheed Martin 14%, 3M 10%, Clorox 7.3%. You know, these are just all big blue-chip companies. Some of these are just conservative, some of you might even call slow growth companies; still able to raise that dividend. Apple, another one of the high techs. Apple didn't start paying until 2012, but since then they've grown it at 9.8%. You know, there's a lot of different ways to get from Denver to LA. Again, looking at another margin of error, you also have to consider that over time, the companies that have made up the dividend of the S&P 500 has transitioned. Several decades ago, it was industrial names. It was big oil- Exxon, Chevron, that made up a big piece of the dividend payment. In the last decade, that really has transitioned to where now, one of the bigger components of the S&P 500 dividend is technology. You Look at Apple, you look at Microsoft, these are two of the largest market cap companies in the entire market. There you have lots of room for dividend growth. Their margins are high, they have a lot of cash on their balance sheet. You have a company right now that's growing at 30% a year and grew right through the recession of last year. There are just several ways that we can get to that same 6%.
Greg Denewiler 10:27
Now, is dividend growth guaranteed? No. But I think if you look back in history, there's just, you know, history has a way of repeating itself in some form. And I think you just have to look at the fact that you've got a powerful trend there. Another thing- another question that may come up, you know, we seem to be getting more emphasis on some of these high growth names like, well, Netflix, Facebook, Amazon. Well, Amazon is probably going to, as they mature, and Facebook's probably potentially the same situation, they quite possibly are going to become dividend payers. Berkshire Hathaway's another one, it's a big one of the bigger market cap companies doesn't pay dividend; never has. But since Warren Buffett is getting to a point where he's not going to be CFO much longer just due to age, it's very likely that that company may also start paying a dividend. So, we don't really need things to be different. We don't even need them to be the same, we just need them to be close to the same. I think, you know, the main story is very much intact. With payout ratios near lows, it makes it pretty easy to attain it going forward, into at least 6% dividend growth which we've had for the last 100 years.
Greg Denewiler 11:51
So one of the things that we want to do this time, it's going to be a little different is we're going to have a short Q&A period. And we're going to entertain a few questions to kind of further examine this whole dividend story. So, this is Ethan.
Ethan Anderson 12:10
Hey, everyone, if you don't know me, my name is Ethan. I'm a producer of the show. I have a whole lot of fun producing this great content for you guys. So I figured we could do a little Q&A. If you like this segment, follow us on social media and comment some questions and we can try and work those into the future episodes. Let's get some of these questions rolling. So, you've mentioned companies with a dividend growth of about 6, 7, 8% over the past 10 years. But ever since 2008, the conditions to do well have been there. So how do you think companies are going to be able to manage similar growth levels in a bear market, or recessionary economy or some extended time period where earnings just don't look as optimistic as they do now?
Greg Denewiler 13:00
Well, you know, there, you know, first of all bear market- what you got to remember, you know, a bear market, part of it is just about prices and the price level. And, you know, a bear market may or may not involve earnings declining. But, you know, for one thing, the dividend, as we've mentioned, in these three lines, the dividend tends to be much more stable. The dividend in 2009, I believe the dividend declined slightly, but only it only took about a year and a half for it to regain its previous high. And companies tend to focus more on trying to keep that dividend stable, or to keep it growing if they've got a long-term track record of that. I also, I also think that you know, with inflation kicking in, that helps you with some price growth right there. And when we do get recessions, which we do, and we will get another one. For one thing, I think that can also help you because, no dividends are not straight line, they don't go up by 6% a year. They do there are some decades when they've only been up 3%. But what you have is you always have; you've always had a reversion to the mean. And what a lower market will do is give you the chance to reinvest. Your reinvestment of those dividends, I mean, that that becomes a huge part of the story. The reality is, you really want a lower market, because you're going to make your wealth on that dividend compounding over decades. I mean, part of it is definitely going to come from price but a great example is Philip Morris. That story was not built on price growth. That story was just built on that dividend over time being reinvested at a continually cheap stock price, because nobody wanted to own tobacco.
Ethan Anderson 14:57
So that leads me to my next question. In several of your examples, you continuously use this target rate of about 6%. Is there any sort of significance behind that number? Or? Or why is that your typical target?
Greg Denewiler 15:12
Well, the I mean, the first simple answer is, because that's what the economy has grown by in the last century. And that's what earnings per share have grown by. And that's what the dividend growth rate has been. But what's kind of fascinating is, when you go back 5000 years in monetary history, interest rates have tended to congregate around between 4 and 6%. Now, why that number is there? I have no idea. But that's the number. So, it just kind of is what it is.
Ethan Anderson 15:54
So, over the past 10 years, bond yields have been historically low, and especially even as late, almost insignificant. Say, if these yields were to go up, either because of interest rate increases or other market forces, would that force you to reevaluate the dividend story? Or would you have to tilt portfolios to include more bond coverage?
Greg Denewiler 16:17
You know, the great thing about the quote "dividend story" is it sort of works in all environments. And as far as interest rates going up, well, right now you have a choice, do you want to own a 10-year treasury bond yields 1.5%? Four years from now, three years from now inflation continues to run 3 or 4%- which I don't know, you don't have to get very far in grade school to know that 3% is a bigger number than 1.5- so you're losing money right there. And number two, that 1.5% is not going to change is not going to go up until that bond matures and you reinvest the money. Right there, if you have a dividend that's growing by 6% a year, that right there helps to protect you against inflation. Will gold do it? I have no idea. You know, gold doesn't pay anything. Last I checked when you got to King Soopers, or wherever you may live to buy your groceries. They're not going to they're not going to trade a Krugerrand for groceries. And guess what, if you take a share of apple in there, they're probably, (actually if the clerk was very intelligent, well, I shouldn't say that), they're not going to take a share of, they're just not going to take a share of Apple stock and let you buy whatever you want for your barbecue that night. But what they will do is cash that Apple dividend check. So therefore, you know, dividends are useful. And not only that, you know, I just don't- even though the environment, especially in the last few years with a lot of these stocks that that have no earnings, just a great theme or a story that somebody has to some degree even made up- where you're getting this 100% growth in weeks or months or whatever. I don't think the impact of dividends are going to decline, because if you're an insurance company and you're trying to make claim payments, part of why they invest in bond portfolios is to get the income. Well, guess what? Income is not too great. And dividend income helps to provide some of that. You look at foundations. Foundation for a school, how are they going to- how are they going to offer scholarships or help pay fund some of the school operations? They want income. I mean dividends, you know, a person that's retired, you know, you just income growth, or income is just a key factor of society and it's not going to change.
Ethan Anderson 19:03
Just to play devil's advocate, is there any scenario that you can envision the dividend growth strategy not working?
Greg Denewiler 19:10
I mean, that's a long answer. But the short version is companies- so you know, it's just, it's just been an historic part of the market. It continues to be. You know, there are times when it doesn't perform as well, and in fact, you know, we're in one right now. Because when you have, when you have Netflix, you have Amazon, you have some of these, Facebook, you have some of these big companies that don't pay dividends. And you know, there's no law that says everything has to pay a dividend. But you're getting a lot of the performance of the S&P- or part of the performance of the S&P 500 right now coming from stocks that are not dividend payers. Right now, I think we're up about 24% roughly, depending on which hour you look. So, the dividend strategy is probably not going to do as well in that environment. But what we're looking at is a longer-term track record. And we're, and we're trying to generate something that you can live off of, you can reinvest. You can do whatever you want with the income, but it gives you options, and it tends to give you predictability, it gives a little bit more comfort. Last year, when the market went down 30%, or whatever it was over a three-week period. When you've got PepsiCo, Johnson and Johnson, Chevron, you know, go down, go down the list of these long-term dividend payers, they're still paying. And guess what, they're paying you more this year than they paid you last year. And they paid last year more than they paid in 2019, even though there was a moment there a few weeks, maybe a little longer, when a lot of people were questioning whether everything had changed. Well, consistency and sustainability tends to survive.
Ethan Anderson 21:10
So say, theoretically, I found a company that looks like it's a great dividend grower, checking all the boxes. What is your analysis process? What do you look for when you're debating whether or not it's time to pull the trigger and execute this strategy?
Greg Denewiler 21:27
Well, if you call Denewiler Capital Management... Well, you know, that's part of the subjective thing to this is, you just don't want to pay any price for dividend growth. Part of what we try to do is: okay, if we're going to get 6% dividend growth, we would like to start out at 2-2.5%. That seems to be sort of the sweet spot. I'm not saying that's the best answer. It's a little bit higher, it is higher than the S&P 500. But, you know, companies that have been more dividend oriented- well, Clorox is a great example, you know, it's just, you know, Procter and Gamble, you know, PepsiCo- they're long-term dividend stories, but there, their yields tend to be higher than the market is as general, because they're, they're perceived more as income stories. They're not perceived as growth stories, but you get a combination of both. You know, what makes those stocks powerful and what keeps them up with the market, again, is that whole compounding principle, it's that simple. We use yield as a little bit of that hurdle- find something at a 2-2.5%. And that's kind of the trend line yield that it's had, and if we're getting it close to what it normally, you know, trades at as far as yield basis, that's one thing. This gets into the weeds a little bit, but you look at, okay, the cash flow after all their capex, if you can earn 4 or 5% on that, (which is not the dividend itself), but that's just how the company's valued. That tends to tell you that, okay, if I get a company, if I won the World lottery and was able to buy the whole thing, and I'm entitled to all that cash, and I spend my world lottery on buying PepsiCo, or Microsoft or Apple, and I get, let's say, a minimum of 4% on that cash from what that company earns right now. That would tell me that, okay, you know, that's a, that's an okay starting point. And if that 4% grows over time, I'm probably going to be in pretty good shape.
Ethan Anderson 23:43
Well, that wraps up all my questions, Greg, thank you, to our listeners. We hope you have the happiest of holidays, and we'll see you back here after the new year.
Greg Denewiler 23:59
If you liked 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 grow my dollar.com. There you will find some of our previous podcasts and also our monthly newsletter. Past performance does not guarantee future results. Each investor should consider whether a strategy is right for them and consider all the risks involved. Dividend Stocks are volatile and can lose money.