Dividend discipline: my sleep-well-at-night secret

I had the pleasure this week of seeing Barron’s publish a letter to the editor I sent it.

No big surprise, it was about something you guys hear me talk about all the time: dividends. As in the sustainable, growing payouts that durable businesses with strong balance sheets and disciplined management teams can provide.

Titled “Dividend discipline,” my letter began by referencing one of America’s greatest capitalists, John D. Rockefeller. He understood dividend’s enormous importance, something too many modern investors overlook.

Or they just don’t understand it to begin with.

But they should.

Many people know that Rockefeller once said that dividends were his only source of pleasure. Which is probably taking it too far. I’ll be the first person to say so if he was being serious about that.

But he was correct about dividends being real proof of a company’s strength.

A business that’s confident in its ongoing operations is much more likely to pay out a steadily increasing dividend. Or as I told Barron’s:

Considering today’s market environment filled with conflict, chaos, and confusion, I believe that distinction is more important than ever.

Believe it or not, I don’t have dividends up on a pedestal. I’m fully aware that even the most faithful dividend-paying companies aren’t outright obligated to keep those payouts coming.

They can be reduced or eliminated, often whenever management wills it. There doesn’t necessarily need to be a dire need behind the decision.

Of course, a company that’s carefully built up a faithful model of paying and increasing dividends is much more likely to continue that trend. It becomes a point of well-deserved pride that management will fight to maintain.

I love how that means more money paid out to people like me. But I also love how it means management is better incentivized to continuously evaluate its future cash flow in order to sustain that track record.

Again, there’s no guarantee here. Companies can raise their dividends foolishly, borrowing money to sustain them, selling assets, and/or distributing more cash than they can actually afford.

Wide Moat Research regulars are well aware of the phrase, “sucker yield,” for instance. It means a dividend yield that looks attractive but is “supported” by unhealthy fundamentals.

You can have a company that yields 14% in the moment. But more than likely, you’ll find it’s working with significant leverage and limited recurring cash flow.

So investors can get big short-term gains yet suffer in the long run.

I’d much rather have a lower yield from a quality company I can count on. That’s why tomorrow’s Wide Moat Show involves Nick Ward and me tackling the topic of high-yielding stocks in depth.

If a company isn’t properly managing its leverage, operating expenses, and capital expenditures, we want no part of it.

Historically speaking, investors have mainly bought dividend-paying stocks for supplemental income, not capital appreciation. And if you’re a retiree, that makes sense.

I also understand how emergencies come up. In which case, it’s nice to have those extra checks to fall back on. However, dividends can also tremendously contribute to building wealth, especially when they’re reinvested over long periods of time.

This is something that Nick covered on Friday. But I’m going to take a stab at it as well today…

A reinvested dividend purchases more shares of the same business. Which generates more dividends. Which can then be reinvested to buy even more shares that can generate even more dividends still.

That puts the power of compounding on hyperdrive.

This kind of consistent repurchase plan also means that, inevitably, you’ll end up buying stock during dips. Every company falls out of favor sometimes, after all. And the larger market never heads straight up forever.

Just as long as nothing changes fundamentally with the company when those retractions occur, you get the opportunity to purchase more quality shares for less.

All of this dividend talk brings me to some exciting news from Wide Moat Research.

We’re bringing back the Dividend Champions, Contenders & Challengers, or CCC, List,

That was started over 20 years by the late David Fish, a dividend-growth pioneer and fellow Seeking Alpha writer. The intent: to categorize companies by how many years they’ve increased their dividends consecutively.

As such, there are:

This simple but powerful concept has since helped generations of investors identify businesses that are committed to dividend growth.

Our relaunched tracker will continue Fish’s legacy through our various Wide Moat Research services. Complete with a new wave of analytical tools, the larger enhanced platform will include proprietary analytics such as:

In short, we want to know which companies have been increasing their dividends… which ones are most likely to continue doing so by way of financially sound decisions that keep them competitively advantaged… and which ones are attractively valued in the moment for shareholders to buy into.

So stay tuned for our official relaunch announcement. We can’t wait to show subscribers what we’ve got!

Here at Wide Moat Research, we’re always focused on acknowledging reality and acting accordingly. So as I noted in my Barron’s letter, the S&P 500 is showing historically low yields these days.

Yet that “doesn't make dividends obsolete.” It simply “makes dividend discipline more important than ever.”

There’s no need to reinvent the wheel here or ditch income investing for hotter, newer trends. We simply need to focus all the more on selecting financially strong companies that pay growing dividends while trading at reasonable prices – or outright bargains.

That’s a very large part of the strategy that made Rockefeller the modern world’s richest man (accounting for inflation). And I don’t see how his obsession with quality dividends is any less effective a century later.

That’s why our philosophy remains as straightforward as ever here at Wide Moat Research. We’re seeking out income, safety, and growth.

In that order.

Happy SWAN investing!

Brad Thomas
Founder & CEO, Wide Moat Research