Q I am a long-term growth investor. Should I care about dividends?
A Income-oriented investors are well acquainted with dividend-paying stocks as a tax-efficient source of spendable cash flow. For investors more focused on growing their portfolios, it is tempting to overlook the contribution of dividends and concentrate instead on price appreciation, picking stocks or funds for their potential to rise in price and generate capital gains. And yet even for growth investors, cash flows from distributions can make a significant contribution to the overall rate of appreciation while helping to attenuate volatility.
Dividends are periodic disbursements of corporate profits to the shareholders in the firm. The concept of making regular fractional distributions of net income traces its origin to the Dutch East India Co., chartered in 1602 as the world's first joint stock company (a precursor of the modern corporation). Prior to this innovation, investors were expected to bide their time until a particular venture succeeded and the invested capital was returned along with its requisite share of the profit. Of course, not all endeavors were profitable, but win or lose, the investment was "dead money" until the conclusion of the enterprise.
The word "dividend" derives from the Latin for "something to be divided"; in this case, periodic allotment of profits. Stockholders now had the opportunity to realize a portion of their investment returns along the way rather than waiting until the venture ended or they sold their shares.
Receiving these cash flows throughout the investment horizon reduced some of the risk and made stock ownership more palatable to a broader array of investors.
Perhaps surprisingly, Standard and Poor's reports that over the past 80 years 44% of U.S. stockholders' total return came in the form of reinvested dividends, and that the dividend yield over that period averaged 3.9 percent.
The trend more recently, beginning with the tech boom of the 1990s, has been toward reduced payouts as companies plowed earnings back into projects that fueled more expansion and more earnings growth.
By 2001, dividend yields averaged a more exiguous 1.8 percent. As long as stock prices climbed, shareholders were content to forego the incremental payments and let it ride.
What a difference a decade makes. Stock prices have retreated over the past 10 years, and companies are feeling shareholder pressure to crank up the distributions. Investors (including growth seekers) would be wise to heed the call of the dividend and behold the power of reinvestment as important sources of long-term returns.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Chris Hopkins is vice president, investments, at Barnett & Co. Inc. Submit questions to his attention by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at jvass@timesfreepress.com.