High Yield, No Growth Stocks Aren’t Some Terrible Blight Upon Humanity

In 2002, Otter Tail made $1.79 per share in profits on behalf of its owners. For those of you unfamiliar with the company, it is a small, $1 billion-sized northern electric company with 2,300 employees. It has 130,000 costumers, and provides power to half of Minnesota and a little less than half of North Dakota. It has a small footprint in South Dakota as well. The earnings don’t grow all that much, as the company spends about 13% of its revenues on fuel costs alone. Plus, it has an extensive dividend commitment that prevents the company from retaining profits and growing significantly over the long term.

In fact, profits haven’t grown at all since 2002, as it only makes $1.75 per share in profits over the course of 2014. From a growth in business perspective, it has treaded water these past twelve years—in fact, it’s actually making a little bit less in profit now than it used to in 2002. The dividend rarely grows; however, it doesn’t decline. In 2002, the dividend payout was $1.06 per share. Now, it’s $1.21 per share. From 2008 through 2013, the dividend was frozen at $1.19 before finally going up to $0.3025 quarterly in 2014. The profits didn’t even cover the dividend in 2008, 2009, 2010, 2011, and 2012, as the company had to borrow funds in order to avoid a dividend cut. This year has finally been a breakout year, and with profits at $1.75, the payout ratio is now at a more comfortable 69% of profits (it’s been in the 60%, 70%, 80%, and over 100% range throughout the past twelve years).

It’s not a company I talk about often because the profits don’t grow, and the dividend hardly ever grows. If you had to make a list of only 25 to 30 stocks, and the condition was that you had to hold the company and hitch your personal fortunes to that of the wagon of the companies you select, it is highly unlikely that Otter Tail would make money people’s lists (though perhaps some folks in the Dakotas and Minnesota, all too aware of their monthly payment, would differ).

And yet, it wouldn’t be some terrible hardship to have to hold this stock. For someone who held the stock for the past twenty years, your money would have compounded at 5.7% annually, almost three percentage points below the wealth you would create by purchasing an S&P 500 Index Fund and collecting you 8.6% annual returns over that time frame. If you did reinvest the dividends, your yield-on-cost improved dramatically, as you were receiving a significant (though static) chunk of income that was able to compound upon itself on eighty different occasions from 2004 through 2014. This boosted your compounding rate to 7.6% annually.

What I find so interesting is the growth in annual income that would have happened, even though the dividend payment didn’t really grow all that much (Otter Tail paid out $0.88 in 1994, and pays out $1.21 today). The reinvested dividends almost tripled your share count—a $10,000 investment would have increased 600 shares of Otter Tail to 1,472 shares of Otter Tail. That catches my interest that a company with a negligibly growing dividend could increase your annual income from $528 in 1994 to $1,781 in 2014. A low dividend growth rate, and the power of reinvesting a high dividend payout, gave you 237% total income growth over the past twenty years. No TV networks will talk about this, the stock is only trading $3 above its 2002 highs right now—and no analyst will recommend it because the company has trouble demonstrating sustainable long-term earnings power (though Bill Gates’ private investment vehicle, Cascade Investments LLC, has been a shareholder). And yet, despite this complete lack of fanciness, the company has been able to deliver returns within one percentage point of the S&P 500 (without dividends reinvested) if you had taken the Otter Tail dividends and reinvested them along the way. If you make an apples-to-apples comparison and reinvested the S&P 500 dividends as well, the gap becomes two percentage points.

To me, that’s crazy—I wouldn’t have intuitively guessed that a very moderate low growth business could come close to keeping pace with the S&P 500 through the sheer power of a high value of dividend reinvestment.

The take-home message from this article isn’t that you’re supposed to go out and buy Otter Tail. Rather, the lesson is two-pronged. On one hand, those high-yielders with limited growth like AT&T and GlaxoSmithKline deserve your respect and attention, because the accumulation of reinvested dividends over time will become significant. And secondly, it’s a reminder not to freak-out when a company you own doesn’t “beat” analyst expectations on Wall Street. A lot of times, people get upset and panic sell McDonald’s, BP, or IBM simply because a quarterly report didn’t meet expectations. These businesses are actually growing profits, just not a rate that pleases Wall Street. They’re not going anywhere; they’re just growing a little bit slower than some might hope. Avoid the inducement to sell low. Even if the low growth hangs around for a while, you can still receive adequate positive returns. And, more likely, when the growth per share resumes, you’ll receive a commensurate (justified) price hike as well that will make you glad you didn’t knee-jerk upon encountering bumps in the path.