John Neff, nicknamed “The Professional’s Professional” for his contrarian and value investing tilt, said this about higher-yielding securities:
“As I see it, a superior yield at least lets you snack on hors d’oeuvres while waiting for the main meal.”
This idea – that above-average dividend payments can tide you over while you wait on the “main meal” of capital appreciation – is instructive. Currently, Texas-based telecommunications giant AT&T (T, Financial) is a perfect example.
From the end of 2011 through today, the share price of AT&T has basically “gone nowhere.” If you were to look at a stock chart, you would see a share price of $30.24 to end 2011. Today, as I write this, shares of AT&T now trade hands at $30.73; that’s essentially no improvement for nearly seven years.
Upon reading this, you might think it is some kind of tragedy. We have had exceptional gains with all sorts of different securities and indexes in the last five to 10 years and yet, here’s AT&T with no capital appreciation for a seven-year stretch.
Yet a wider perspective is required to take in the whole picture.
For starters, you have to consider dividends received along the way. This was alluded to above, but it doesn’t usually show up in a stock chart. Here are the per-share dividends AT&T paid from the end of 2011 onward:
- 2012 = $1.76
- 2013 = $1.80
- 2014 = $1.84
- 2015 = $1.88
- 2016 = $1.92
- 2017 = $1.96
- 2018 = $2.00
Over the past seven years, AT&T has paid out $13.16 per share in cash dividends – equating to over 43% of an investor’s starting investment. This has important ramifications. For one thing, it means that instead of nonexistent returns, shareholders have actually seen a total return of about 5.5% per annum. Granted, this is not spectacular, but it’s a far cry from the information you might glean by glancing at a stock chart.
Further, if you were reinvesting along the way, your cash flow would have grown tremendously. You would have gone from collecting approximately $580 in annual income on a $10,000 starting investment, up to collecting roughly $940 now. That type of income growth is not readily apparent when you see the small dividend increases each year. It’s a result of a well-above-average dividend yield being plowed back in at that high starting yield.
The point is AT&T’s dividend component should not be overlooked. It’s a significant contributor; and for the last seven years – at least from end of 2011 to today – it has basically been the sole provider of returns.
The story is not over yet, though. You can think about this “dividend hors d’oeuvres” idea on a forward-looking basis as well.
Back in 2011, AT&T was trading hands at $30.24, earning around $2.20 per share and paying out a $1.72 annual dividend. Those numbers equated to a 13.7 starting earnings multiple, a 5.7% dividend yield and a 78% payout ratio.
Today, the share price is basically where it was, but the business side has improved dramatically. AT&T is anticipated to earn $3.50 per share this year and pay out $2.04 in dividends for 2019. Those numbers equate to a starting multiple of 8.8 times earnings, with a 6.6% expected yield and 58% payout ratio.
In other words, considering growth expectations are still about the same – in the low-single-digits – the security is trading at a lower valuation with a higher dividend yield and better-covered payout. While the share price has declined as of late, the business is getting better – allowing for a “valuation spring” to continue loading.
Here’s an illustration of how this could play out. Or expressed differently, how the “loaded spring” could eventually launch. If AT&T were able to grow earnings by 3% annually, you would anticipate the company could earn approximately $4.05 after five years. A typical multiple for the security over the past couple of decades has been in the 12 to 15 times earnings range.
At 13 times earnings, this would imply the potential for a future share price of about $52. The earnings improvement helps, but really it’s the possibility of shares going from aroung 9 times earnings up to 13 times that really adds the extra kick.
Of course, we cannot forget about dividends. If the dividend were to continue to grow by 4 cents annually, as has been the case since 2008, you would also anticipate collecting $10.60 in cash dividends along the way. Put together, that equates to the possibility of $63 in nominal value after five years.
Granted, this is merely a guess based on current estimates of business performance and what has been typical in the past. Still, it illustrates what is possible – an investment that doubles in the next half decade without spectacular business performance.
Just as important is remembering the idea of “dividend hors d’oeuvres.” There will come a time again when AT&T’s share price languishes – just as it has recently and over the last few years. Yet this alone is no great tragedy.
For one thing, you have well-above-average dividends to snack on as you wait for the main meal of capital appreciation. And in AT&T’s case, with a starting yield north of 6.5%, you really don’t need much (or any) capital appreciation to generate an investment thesis. Of course, in this scenario, the safety of the payout is vital, but it remains that share price movements (even significant ones) are independent of whether or not that cash payment shows up every 90 days.
Equally interesting is the idea of the business getting better while the share price stays the same or goes down. This can be easy to miss if you’re fixated on a stock chart. Yet the regular cash inflow ought to remind you that you’re not going to go hungry.
Disclosure: I am long T.Â
Read more here:
