Finding blue-chip dividend-paying stocks is one of the best ways to grow your wealth over time. These companies have paid a dividend consistently over the years over a great double compounding effect that is hard to beat. We will discuss some of the myths of dividend-paying blue-chip stocks and why they are in some cases avoided by the investor for flashier, more exciting opportunities.
- The definition of blue-chip dividend-paying stocks.
- Accumulating dividends is better than selling shares for income.
- A hot topic is reinvestment versus dividend payouts.
- Some of the best dividend payers are “boring” companies.
- Blue-chip dividend-paying stocks are great wealth-building machines.
Welcome to session nine of the Investing for Beginners podcast. Today myself, and my co-host Andrew Sather of einvestingforbeginners.com will be discussing some myths about blue-chip stocks.
Andrew: Yeah, so I want to talk about blue-chip stocks tonight. And specifically, dividend-paying stocks. Because on the one hand they are very popular and people like to look to them. You have indexes like the Dow that are made up of blue-chip stocks; and turn on the TV, people always talk about the blue-chip stocks.
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You have these stereotypes about stocks that pay dividends, specifically blue-chip stocks that pay dividends. As a big dividend investor trying to buy stocks at a discount to their intrinsic value, these myths that I want to address are something that can turn people off from dividend investing.
And maybe we can figure out if these ideas are really valid. Then we can understand them and feel more confident. And additionally, know what to look for when it comes to picking the right blue-chip dividend-paying stocks.
Dave: That sounds like a great topic; it would be interesting for me and to learn a little bit about this subject. It would also be interesting for our listeners, too. Dividends are obviously a very big, important part of investing. And it’s a great way to earn income and that is what we are all here for. As you have mentioned in the past, investing for income is what we are all about. I know that we have some different topics that we want to talk about.
In particular, the myths surrounding dividend-paying blue-chip stocks. So why don't we talk about the first one?
Selling shares is better for income than dividends?
Andrew: So there’s this idea that No. 1 you can buy a stock and if it grows let’s say 20% in one year, this idea is even though this stock didn't pay a dividend it grew 20%; compared to it a typical blue chip that pays a dividend and is yielding 3% or less.
So the investor says, "Look here, I have my nondividend-paying stock that has gained 20% and now I am going to sell for the 20% gain and now I have income. This is something that people justified not buying a dividend-paying company."
They will use this argument as one of the first arguments that I don't need dividends because I can sell shares for income. And I really think it is super basic the whole point of growing dividends; we talked in the previous episode of creating that DRIP machine, the drip coffee machine that accumulates shares over time.
When you're selling shares early in order to receive some sort of income what you are doing is cutting away at your real ownership. So, yes, even though you did earn 20% the first year, if you now have nine shares of stock instead of 10, you're losing that ownership. So it can really hurt if the market goes down instead of up.
If I compare that to a dividend blue-chip paying stock like IBM (NYSE:IBM) with a yield 1% to 3% you might think as an investor even though I got a 20% gain even without getting paid a dividend, if I sell the 20% I gained.
Compare that to a smaller yield of the blue-chip stock. You might originally think that you got a better deal. The problem is – and I have referred back to this before – the whole idea of buying stocks, investing your money, you want to receive the income and the dividend. The purpose of growing how much ownership you have of any given investment. We are talking about the reinvestment part.
It's the dripping system that we talked about in the previous episode where you can create this sort of coffee drip system. It is the same type of idea when you are buying dividend-paying stocks. So when you are selling for income instead of receiving the income from dividends, you are essentially slowly chipping away at your wealth potential, your ownership. And over time it is not going to be a good idea. Especially when stocks fluctuate, when stocks don't go up all the time.
What happens in the year that you lost money? Now you could be down 10% from the 20% you were up and then you compare that a consistent dividend payer like Proctor & Gamble (NYSE:PG). The investors in Proctor & Gamble, they might have made a small percentage the first year, but they reinvest those dividends. The second year the whole stock market could crash 20%, but the investors in Proctor & Gamble would still get their income. And again would still grow their ownership and that would continue to grow.
It is like a balloon that is building this pressure. Somebody who is not buying a dividend-paying stock is, No. 1, instead of growing ownership is shrinking it. And No. 2 really, really depending on the results based on the timing of the market.
If you pick up any investment book that is worth its salt, you will see that timing the market is really a fool's errand. And this idea that you can sell shares for income not only is it not sustainable but it's really just a way to deceive yourself into thinking that a growth potential stock would be better than a steady dividend-growing payer.
Dave: Dividends to me kind of equal long-term horizon. I think of them as something that is going to pay me down the road when you are looking at buying a stock or a company that doesn't pay a dividend.
Like Fiat Chrysler (NYSE:FCAU) for example; it doesn't pay a dividend. It's a great company and I know that Mohnish Pabrai is a big shareholder and is very proud of the company, thinks it is doing great things. But one of the thing that shied me away from it was the fact that it doesn't pay a dividend. And even though the company is doing well and it is growing, it is still not paying a dividend. It doesn't mean it won't in the future, but right now it is not.
As you were saying to get income from that particular company when I'm in my retirement, hopefully. I will have to sell shares of my ownership to receive that income, which means like you were saying I am whittling away at that pile. Which means I will have less income going forward regardless of whether the price is up or down.
Like you were saying about timing the market, it is very much a fool's errand. Dividends to me are a long-term growth strategy and like with what we had talked about with the coffee cups refilling, and refilling that's what dividends do to you. They are the gift that keeps on giving. It is a great way to help build your income.
Talking about a couple of companies that I was reading about recently. One of the myths about dividend companies is that they're not going to grow as much. The dividends that they can pay in some of these dividend kings and dividend aristocrats are gonna pay from a 2.5% to 4% dividend every single year. And they are going to grow that over time.
When a company does poorly or the stock market tanks you're still going to be getting that income from that dividend. And that's where the dividends can be such a huge impact or lasting impact on your income and your wealth as it goes along.
Especially someone like Andrew who is much younger than I am. You have all these years to accumulate all those dividends. I am envious of that and anybody else that is listening to this that is younger; this is one of the keys to your success is trying to grow those dividends because that is where the true wealth is going to come from.
So I think owning a stock and selling at some point down the road is not the best idea for helping build your income when you're in retirement. After all, this is what this is all about is looking 20, 30, 50 years down the road. When I am sitting on the beach drinking that pina colada, I don't have to worry about where else am I going to get my money from. Because if you have Coca-Cola (NYSE:KO) it is still going to be paying you a dividend most likely if it is still around by then. Although I am sure it will be.
Andrew: Before you say that Coca-Cola is going to go away because everybody's becoming a health freak. People aren't going to give up their Coca-Cola; they're just switching to Diet Coke.
I will say this, too; you mention retirement. The tag of our show is the path to financial freedom. So if you really examine what financial freedom is in the very, very basic idea of it, you have something that sustains itself.
You have this what they call retirement egg and then you are receiving income from it. What's great is if you can get to a nest egg that's big enough to give you basically enough to pay for your expenses. If you can have dividend income that pays off all your expenses and you are also buying blue-chip stocks, you're buying stocks that are growing dividends over time. Not only are you not killing the goose, so to say you're keeping that nest egg there.
It could be potentially growing because you would be living off some of the dividend income and you could be reinvesting some of it. Or the companies could continue to grow on their own. So you could be enjoying all of this nice income and seeing that income rise over time as the companies raise their dividend payments over time.
And you talked about dividend kings and dividend aristocrats and these are all lists that are freely available online that are companies that continue to grow that dividend and that's really a big draw to the market and unfortunately a lot of people don't see it for whatever reason. It eludes their sight and so they use justifications like the ones we're talking about today.
In effect completely ignore that there is this whole other potential out there and they are really missing out.
Dave: I would agree with that and I think part of why people don't see them or ignore them is because a lot of these companies are not flashy. They are not exciting, and they're boring.
Boring is safe, boring is long term, patient and not exciting. They are not exciting to talk about at dinner parties that I just bought 250 shares of Coca-Cola. It is not exciting, but it is the way that you grow your wealth. It's by doing those things.
Reinvesting in the business is better for shareholders than paying a dividend
Andrew: That would be definitely not. The model that people like to follow is that Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) and Warren Buffett (Trades, Portfolio) is president there obviously. We obviously respect him and think he's one of the best investors out there.
But it's funny because if you buy shares in his company, it's done well for them because he's been just fantastically successful, but I think the model itself is not good for shareholders even though people will argue it is.
What this model I am talking about is companies will make a profit and once they make that profit they have cash. So what can they do with the cash? They can either give back to the shareholders or they could put it back into the business to try to grow more cash for tomorrow.
Why would they even pay a dividend? If the market was more rational than it is today, if more investors understood the power of dividends and understood why dividends are an essential part of any sort of investment philosophy, you would see even more companies trying to pay shareholders dividends.
But because people get attracted to the light, they get attracted to all these flashy things they wanna to run to Vegas and take that nonstop from Wall Street to Vegas.
Because that is the case some of these companies get away with not paying a dividend. As a shareholder, if we would vote with our money and put more money into stocks that pay dividends, then would it keep more management honest and they would see that our neighbors of AT&T (NYSE:T), Verizon (NYSE:VZ) and Walmart (NYSE:WMT) are paying dividends.
And they're getting all of this investor capital flowing into their stocks, and their stocks are shooting up. If that were the case in the market, then a lot more companies would see this success there and they would emulate it. And they would pay high dividends themselves to try to attract shareholders.
That is what utopia would be like; that is our ideal world. That's basically why companies pay shareholders a dividend because it attracts more dividend, more capital into the stock price, and the stock price goes up. Management is happy because their stock options are higher, the bonuses are higher.
Now because we don't see this ideal play out in the real world, a lot of companies get away with not paying a dividend at all. And only reinvesting in the business. If you talk about a business like Warren Buffett's Berkshire Hathaway, that's worked out really well for them because they've been able to take the machines they use to print money in the vault. They take a dollar and a $20 bill spits out. Also, their businesses don't have that kind of technology egg.
There is just not that kind of compounding and efficiency in all those sorts of things. So, on the one hand, you can try to look for companies like Berkshire who are returning a lot of money based on when money is going in but what I really believe is that as an investor you want to invest in the system and not in situations. A good system has a balance and how can you expect anything to grow if it isn't exposed to sunlight. A business is going to have to make a decision on how much it is going to reinvest and how much it is going to pay out.
A business should be buying assets that are going to create more return for shareholders and for everybody involved. The problem comes when they're doing too much of it and some companies do it to the extreme. Some of them won't pay a dividend at all. You tend to see this in the growth stocks, you can always point at the success stories, but you have to accept that for every five or six successes there are a hundred failures. That is not a system that you want to invest in and definitely don't want to put your money in because again you’re going on a nonstop direct flight from Wall Street to Vegas.
Don't look back or don't slow down. You want to get systems that are going to work. A big problem with where a system can break down again. When you allow management to make the decision it will make and you will react to that, understand that when you buy a stock you are becoming a part owner. Remember that every person involved is looking to turn a profit, earns a profit; everybody gets cash.
Sometimes cash goes back into the business. Sometimes you need to restock inventories or the taxman cometh, or there is a rush on snow shovels, like last weekend in Wisconsin. If you have a business where management isn't really getting more money, they aren't really shareholders so they might see more incentive to make bonuses much bigger for all the top executives that are there. Way bigger than the industry average. You just might be seeing executives squandering it away on fancy offices or pointless expenses that really don't need to happen, but management is allowing to happen because there are no consequences behind them. So as a shareholder really the only way you can find and give yourself power is to walk away.
In these situations, I am talking about walking away from companies that don't align with the system we want to be in. The system we want to be in is a system where management takes care of its shareholders and understands that some of the money needs to go back in the business to grow the business. But it needs to be in a prudent fashion.
And there needs to be money also distributed to the owners who are sticking their necks out there. Risking this money so that the company can grow.
As a shareholder, you need to identify managements that are on your team and not against your team. And I believe that if a company pays a dividend and does it a prudent way, then they're echelons better than a business that doesn't pay shareholders any dividends and uses the excuse that they are just going to grow the business.
Dave: I think one of the points I was thinking about while I was listening was you mentioned Berkshire Hathaway and Warren Buffett. Of course, he's one of my heroes and amazing person and obviously an incredible investor and far better than I'll ever be.
I think in his case it's a little bit of doing as I say, not as I do.
I will also throw this out there. With Buffett, he is a special circumstance. And I know that people use that as a linchpin to making their argument for reinvesting in the business than paying a dividend because Warren Buffett does it.
The thing about Warren Buffett, he is such a fantastic allocator of capital, bar none. And he's been able to take that money that he has instead of giving it to the shareholders. He’s been able to use that to buy fantastic businesses that have grown the value of Berkshire such that it's made it much more valuable. So whenever he adds on a company like Heinz (NASDAQ:KHC), Precision Castparts (NYSE:PCP) or Geico those companies are going to pay off, maybe not in dividends but they are going to help grow his business which is what he's trying to do.
To me, when someone brings that argument up that's more of an outlier as a reason why reinvesting in the business is not better for the shareholders.
I will give you an example, Amazon (NASDAQ:AMZN). It is an amazing company and a force to be reckoned with. But when you start digging into the number and looking at the numbers, they are not making a whole lot of money and their reinvestment in the business is all about reinvesting for growth.
They pay no dividend, they have no plan to pay a dividend. Who knows if they ever will pay a dividend? Right now they’re in kill all competition mode, and Walmart is one of the competitors with the online business.
Granted they are not really in the same league as Amazon, but it is definitely on Amazon's radar. And it is doing everything it can to try to beat Walmart down. And Walmart is trying to do everything it can to try to hang in there with Amazon.
You could argue that instead of Jeff Bezos having such an aggressive mindset maybe it would be better served to look at trying to bring his shareholders along and try to grow them as well. The stock is selling for $849 right now so it is obviously not hurting, but its (price-earnings) P/E ratio is also 172.8 which is just crazy.
But it's not the model I want as a company that I want to buy; I am looking for companies that are going to pay me a dividend and help me when I get to retirement to buy my pina colada on my beach.
And I don't think at this point Amazon, for example, is that type of company. Do I think it is a bad company? Absolutely not. I think it is a fantastic company and Jeff Bezos knows his stuff and is really, really good at what he is doing. But its method to the madness is not something that I want for me personally as an investor.
My system is to avoid companies like that and to use my money to vote. I am voting to not buy Amazon because it doesn't follow the value that I want for the business to pay me. When I give my hard-earned money to it, I want a return on my investment. I would prefer that to be a dividend and if it is not doing that I may say to myself this is not what I want to be in.
Andrew: I love how you say that Jeff Bezos isn't bringing shareholders along because that's a huge point to understand. An investor who bought stock when it was half as expensive as it is now.
They might think they are coming along for the ride, but they are not collecting dividends all along the way. This kind of goes back to the same point we made before. If you are not collecting dividends along the way, what happens when the stock crashes just like history has shown us all these stocks with super high P/Es that just crashed and never recovered?
So what happens to an investor who buys Amazon at $400 to $600 and the stock goes down to $200 or less? Or if the P/E ratios revert down to a more reasonable number. Dividend investors might lose on some share price appreciation, just like everybody would. But along the way, they would grow their ownership like we've said and collected these dividends. They're still on the positive side of compounding interest.
An investor who’s not getting along with the ride and not seeing any of these profits. They do not really profit until you see a sale. They are only paper until then. Now all of sudden you are trying to be a market timer, even though you think you are along with Amazon's ride you are really not because you're not until you sell. And how are you going to know when to sell? How can you expect to have a good chance of making a good profit when you are buying with a P/E of 100?
Dividend companies are maturing and not growing.
Dave: I want to take a stab at this real quick My thoughts on that are that is kind of bunk. I will give you a couple of numbers to back what I am throwing out there.
You’re talking about "boring companies." Coca-Cola since 1964 has grown annually 14.4% a year since 1964. The S&P is at 7.63 for the same period. Let's also throw out Chevron (CVX); it is an oil company, kind of boring. It is at 11.7% since 1970. Both of these companies pay dividends greater than 3%. Chevron is 4.1%, and Coke is 3.1%.
So these companies in addition to growing at 11.7% annualized over a 37-year period, they have also been paying a growing dividend for 54 years in Coke's circumstance. Longer than I've been alive. They have been paying a dividend that is growing every single year.
So in addition to the 14.4%, you would have earned for those 34 years depending on which company we are talking about. You also would have had that dividend that would have paid you as well. So I challenge someone to find me a company since 1964 that would have grown at an annual of 14.4% and paid a dividend of 3% to 3.5% along the way with that, that could beat that over that time period. I don't think you can.
Maybe it is maturing, but Coke, for example, is adapting. As Andrew mentioned earlier people are changing their beverage choices. And maybe there is a backlash against soda companies right now. And maybe there is, but Coke is smart enough to realize that and is pivoting off of that. It is buying companies that produce bottled water, juices, teas because people are always going to want a beverage other than water.
So it is trying to find a different way to make money, and that's smart – to adapt to what's going on around it. Yes, it may be "mature," but it is still growing, adapting and figuring out a way to make things happen. The oil companies are going to do the exact same thing. As energy needs change they will adapt along with them. Or they will go out of business.
Andrew: The power of these companies is really amazing and there is a saturation point at which point it will end. We are all anxiously watching to see as Apple (AAPL) continues to break through. At what point will it reach a point of market saturation? And as its market capitalization goes all the financials that go along with that.
But there's that stereotype you’re talking about where people think if it's big and it's paying a dividend, it must be paying a dividend because it's not growing. Dave has already given fantastic examples of where that is obviously not the case. And you want to define where there is big and too big. I think that is a subjective thing,
I'm not sure if Apple is too big just because we've never seen a company like Apple before but if we look at historical market cap numbers, you can look at a company like Exxon (XOM) and maybe make more of an argument against that because there's only so many gas stations so many oil rigs whatever that may be.
If you want to talk about specifically blue-chip stocks, the definition for blue-chip stocks is varied, you can see different headlines and media like this stock blue chip and that stock blue chip.
They might be wrong, they might be right. In general, a lot of people agree that a blue chip stock is one that is a large cap. So where you define a large cap is subjective. You could easily say like over $10 billion, at least which is what finviz defines anything as a large cap if it is over $10 billion in market cap.
So let's use that example. I pulled up a quick little screen and I want to look at these blue-chip stocks paying a dividend and according to the net, these blue chip stocks paying a dividend should be saturated.
I looked at one financial metric; let's look at companies that have grown EPS over the past five years by over 25%. Right away we come away with 38 companies. AT&T, Bank of America (BAC), Altria (MO), Verizon, Goldman Sachs (GS), the list goes on and on if these 38 companies grow their EPS by over 25% as an average for the last five years.
Sure, not all of them will continue that kind of growth, but this is solid evidence saying that even though these companies are swelling up and getting big, they are still able to not only grow their business and take big chunks of money and turn into bigger chunks of money. At the same time, they are doing that they are taking bigger chunks and giving them to the shareholders. You don't have to buy a stock like Apple when it was at $2 a share, or Amazon when it was $10 a share. You don't have to find the small company that just hit the jackpot and exploded.
That is more like trying to buy a lottery ticket and if you look at the numbers behind how many small companies actually make it to a grand scale like that, we are not just talking about companies that exploded their share price, but they revolutionized an industry in a way that we know it in the world.
And there's no way to predict which one it will be. What next innovation, groundbreaking product, no one has a crystal ball; if anyone did we would all be putting money into those things.
Better instead than trying to play the guessing game; why not buy the companies that are already set up and have the systems to take large amounts of cash, turn them into more cash and take another large portion of cash and pay it to shareholders.
A company like Coke is buying companies, and that's a good way to reinvest money into the business. What you'll tend to find, and the past doesn't equal the future but you'll tend to find companies that tend to have grown by large percentages over long stretches of time are able to continue to do that.
Because from day one management is making the right decisions and they're being smart with their money and buying the right companies as they grow. There's a good chance they will continue to do it. The business model's probably solid; management is looking at similar businesses models that they understand.
You really want to make sure you’re in the right system, making sure that you're getting into a company that's treating you right.
It's continuing to grow over time and find companies that have these profitable business models in place. Systems in place that will compound your capital by being smart with their money and reinvesting and growing the business in that way. And you’re compounding your capital by collecting dividends and growing your ownership piece of the business.
That’s going to do it for tonight’s session. I hoped you enjoyed it and found it beneficial. If you have any questions you would like to discuss with us on air please reach out to myself or Andrew to make that happen.
If you are enjoying the podcast please give us a review on iTunes. This helps get it in front of more people that we can try to help.
Dave and Andrew
Disclosure: The author does not hold any positions mentioned in this article.
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