On CNBC last week, a financial analyst/TV pundit went on air and said, “We are bearish on AT&T—it hasn’t grown its profits at a rate above inflation in a very long time. We don’t have it in any of our client portfolios.” Now, the statement by itself isn’t necessarily indicative of poor investment thought—I would imagine an investment portfolio consisting of Franklin Resources, Nike, Visa, Disney, and Becton Dickinson would create more aggregate wealth than AT&T stock.
Discussing the telecom giant’s 2% growth rate in isolation does paint a picture that would blend in with what the analyst said. But there is a catch: it’s not the whole picture. It’s like only talking a supermodel marrying an overweight old person without disclosing the fact that the person is also sitting on a million-dollar fortune. The totality of the facts affect your judgment of an action. In the case of AT&T, the important fact that often gets ignored is this: the starting dividend yield is often above 5%, and it grows (albeit slowly) each year. High dividends, perpetually reinvested upon themselves, can overcompensate for slow growth.
From 2004 through 2014, AT&T’s annual dividend grew from $1.25 to $1.84. That is cumulative growth of 47% over ten years. That, by itself, is no cause for celebration. However, the shares were often valued in the $20s and $30s, enabling someone who bought 1 share of AT&T stock at the start of 2004 to create 0.7 new shares of AT&T stock by the end of 2014. That is the part that is frequently left out of the equation. While the dividend and share price grow at a very moderate pace, the share count increases much more rapidly, creating a hidden compounding effect as 100 shares of AT&T grew into 170 shares of AT&T over the most recent ten-year period. The actual compounding effect works out to around 8% annually (depending on where AT&T’s share price is), which is much more substantial than studying the growth rate alone would indicate.
My point has more to do with the general principles of how you approach income investing rather than just AT&T specifically. When investors only study a company and review its growth rate or stock price changes, it can create a distortion in your understanding of what is happening because newly acquired shares resulting from dividend reinvestment don’t show up in most calculators unless you manually take them into account yourself.
It’s the reason why it is a glorious thing to have a retirement account stuffed with GlaxoSmithKline, Royal Dutch Shell, BP, AT&T, Philip Morris International, and a few others. Your returns will be adequate if those businesses merely maintain the status quo, and you take your chunk of profit and reinvest them into new shares that also pay out 4%, 5%, or 6% yields. This is especially attractive compared to 0.5% bank accounts, and the safety of something like Royal Dutch Shell with $400+ billion in annual revenues makes it unlikely the dividend payment will be lower five years from now (but then again, oil sliding to $50 was also highly unlikely, giving us a timely reminder on the difference between no risk and little risk).
There is a catch: You don’t want to overpay for these companies, because the earnings per share growth rate of these companies is rarely strong enough to help you out when the P/E ratio of these shares comes down. For instance, if someone is dissatisfied with his 1.5% annual returns with AT&T stock since 1999, the problem isn’t really AT&T the business itself, but rather, the price paid for the stock. Back then, AT&T traded at 24x profits. You can pay 24x profits for Nike or Visa when they’re growing at 15% annually; you can’t do it with a slow-moving telecom that’s growing at 2% to 4.5% each year. The problem for AT&T investors that bought in 1999 and held through 2014 is that the P/E ratio went from 24 to 14—if no P/E compression occurred, the results would have been in that 8% range.
The moral of the story? Companies like AT&T, Royal Dutch Shell, and GlaxoSmithKline generate more attractive returns than they ever get credit for, because the new shares created through reinvestment are rarely a portion of the analysis. The drawback is that the present dividend is much more of your returns than the growth rate, and you have to be special attention not to overpay. That may be true with almost all investments, but is especially true when you enter the world of high yield, low growth investing.