What Is The Best Argument Against Blue-Chip Dividend Investing?

I received an interesting private question from a reader recently, asking me what I thought was the best argument against blue-chip dividend investing. I loved that question, and with his permission, I included parts of my answer below.

When you think about owning a diversified basket of high-quality assets for a long period of time, one of the virtues of the strategy is that it is almost fail-proof. Part of me wants to reach out and say, “Yeah, well, maybe during a WWII type of event, the dividend payouts might stop.” I have no idea what will happen during the outbreak of the next war, but here is what I do know: When Germany was streaking across Europe and launching air attacks on the British empire, the highest quality companies in the world continued to make their payouts. General Mills, AT&T, General Electric, Hershey, Colgate-Palmolive, IBM, and the offspring of the Standard Oil managed to return cash to shareholders throughout the 1930s and 1940s (that’s the wild fact—the financial crisis of 2008-2009 did to GE shareholders what the Reichstag and its Chancellor couldn’t do).

Especially if you build a portfolio that has 0% allocation to financial stocks and tech companies, it is almost impossible to go wrong with blue-chip investing if you have a diversified collection of high-grade assets held for 20+ year periods of time.

The best criticism against dividend growth investing, then, is not so much that dividend growth does not work, but rather, that there is a more reliable way to build greater wealth that creates an opportunity cost of money that could have easily been earned but has been “left on the table.”

For instance, Tweedy, Browne put out this excellent research paper titled “What Has Worked In Investing” that is a dry read but is probably worth your time if you want to bring an added intensity to your investment game.

http://www.tweedy.com/resources/library_docs/papers/WhatHasWorkedFundVersionWeb.pdf

The basic premise is this: from 1926 to 2006, a basket of small-cap stocks in the United States delivered annual returns of 12% per year, on average. A basket of large-cap American stocks, meanwhile, delivered annual returns of between 9-10% per year. Don’t let those two percentage points fool you: over an investment lifetime, they make a world of a difference.

Someone that saves $500 per month for 40 years and earns 10% will end up with $3.1 million. Someone that does the same thing and earns 12% will end up with $5.8 million. The notion that you could go to the Vanguard website by clicking here: https://personal.vanguard.com/us/funds/snapshot?FundId=0048&FundIntExt=INT

And then open an account either with The Vanguard Small-Cap Index Fund (NAESX) or Vanguard Small-Cap ETF (VB) for fees of 0.24% annually and 0.10% annually, respectively, is something worth at the very least contemplating. Over eighty years of research indicate that a buy-and-hold strategy of doing nothing but adding to small-cap indices could create 12% annual wealth, better than almost every American fund manager of the 20th century. It’s somewhat startling to think that you could be a completely mindless investor, ignorant of every investing truth except for “buy small-cap indices on autopilot for the entirety of my life” could lead to much, much better returns than a strategy of monitoring your own holdings and spending 10-25 hours per week thinking about your own investing profile.

Why, then, aware of this fact, don’t I follow a strategy of only holding small-cap indices?

First of all, American history only shows us that small-cap indices beat large-cap indices, but they do not show us that small-cap indices beat the best large-cap blue chips over long periods of time.

For instance, take the “Master List of Stocks” that I have had put in bold since shortly after I created this website: ExxonMobil, Chevron, Clorox, Colgate-Palmolive, Pepsi, Coca-Cola, Johnson & Johnson, Hershey, Procter & Gamble, Nestle, Berkshire Hathaway, Wells Fargo, Kellogg, and General Mills.

I can’t really access data back to 1926 for those companies, but I can do about half of that and go back to 1970, a time during which each of the companies listed above (excepting Berkshire Hathaway) was already a large blue-chip (some people get this idea in their head that these companies weren’t large 40-50 years ago, which is absurd. Procter & Gamble had to divest Clorox in 1958 for antitrust reasons, and Standard Oil was such a monopoly that it had to be broken up into Exxon and Chevron, the cereal giants weren’t allowed to merge, and so on).

Anyway, since 1970, Exxon Mobil returned: 14.98%. Chevron returned 13.26%. Clorox returned 14.13% since 1983 (I couldn’t find 1970 data on Clorox). Colgate-Palmolive has returned 18.15%, making it one of the best investment in the world over the past 40+ years. Pepsi has returned 14.23% since 1977, the earliest data I could find. Coca-Cola has returned 12.59% over that time. Johnson & Johnson has returned 13.29%. Hershey’s data I could only find dating back to 1985, at which point it was 14.56% annually. Back on the 1970 track, P&G has delivered returns of slightly over 12.5% since then. Nestle hasn’t been available to middle-class investors in a real way until 1996, since which the returns have been 13.88%. Berkshire’s returns have hovered around 20% during any point annually you bought during the 1970s, but that comparison is less useful because it wasn’t a large-cap then and the company relied more on the managerial excellence of Buffett and Munger than the underlying strength of its brands. Wells Fargo data only goes back to 1984, since which it has delivered 17.53% annual returns. My Kellogg data only goes back to 1984, since which the company has given 11.99% returns to investors. My General Mills data only goes back to 1983, and the company has returned 14.92% annually since then.

In my case, my personality is such that I like to know exactly what I own and why, and I like to know that it can’t be taken away from (short of a court order from a judge). With small-cap indices, you’re not developing an investment in any specific companies—the same companies held in 1950 are not the same firms held in 2014, so the holdings are always ephemeral in that sense. Meanwhile, someone buying and holding, and reinvesting the dividends of General Mills gets to gradually see their ownership stake in the cereal maker increase. Unlike an index fund which sells securities due to predetermined criteria when the time calls for it, nothing parts you from your General Mills shares until you actually decide to sell.

Second of all, I am wired to like to see forward progress. With income, you can do that. You can see your 100 shares of Johnson & Johnson go from paying out $264 annually to $276 annually (whatever Johnson & Johnson’s next dividend rate may be). And if you reinvest, it will go up even more. You can always see the forward progress happening before your very eyes.

This is useful for planning. Financial columnists write 1,000s of articles about “When are you ready to retire?” ad nauseam, but the truth could be described in a sentence: You are ready to retire when your annual income meets or exceeds your annual expenses with a satisfactory margin of safety that you would feel comfortable departing from the work force and relying on those income streams. If you need $60,000 in 2017 to live off, then a dividend strategy lets you regularly track your progress towards your goals. If you own 2,000 shares of BP and the quarterly dividend gets hiked from $0.57 per share to $0.60 per share, then you can see that BP stock is going from giving you $4,560 in annual income to $4,800 in annual income. The stock goes from representing 7.6% of your target retirement amount’s income to 8.0%.

In short, I think someone could do very well with a basket of small-cap indices. But I think someone owning the highest quality blue-chip stocks has a chance of producing total returns equal or superior to a basket of small-cap stocks, and plus, they come with psychological rewards. When Coca-Cola falls 30% in price, you can feel comfortable writing a check for more shares because you know $10 billion in profits across 200 countries with 500 different soft drink brands isn’t going to disappear. And plus, they give you regular streams of cash, which make it much easier to allow you to follow your goals. And plus, you have complete authority over your holdings. Those are the factors that combine to give me the confidence to execute the strategy I’m pursuing.