With BP on my mind after writing last night’s article, I was once again a bit surprised to study the full effects that dividend payments can have—not just in terms of total returns—but also in providing a cushion against the next fall in the price of stock. The list of companies with worse PR issues than BP is indeed short, and people who remark that the price has little changed since 2010 are, of course, right.
But here is what I see: $1.68 in 2011 dividends, $1.98 in 2012 dividends, $2.19 in 2013 dividends, $2.34 in 2014 dividends, and (projected) $2.40 dividends in 2015. The price at both the start of 2011 and the middle of March 2015 may be $40 per share, but the underlying reality is this: You will have collected $10.59 in dividends by the end of this year. To sustain a paper loss, assuming you bought at $40 at the end of 2010 or before the first dividend payment of 2011, you would need to see BP trade at a valuation of $29.41 or less. And that is assuming you collected the dividends as cash—the amount that BP stock could plummet towards would be even more substantial if you had been reinvesting your dividends during the past five years instead of having the payments pile up in a cash account.
This cuts to the reason why Royal Dutch Shell delivered 14% annual returns over the course of the 20th century. The dividend payments are high, and as the business improves due to production growth in the form of more barrels of oil being dug up each day, the valuation increases to reflect this so that those high reinvested dividends carry even more value.
Someone who has owned Royal Dutch Shell over the past five years has received the following dividend payments: $3.36 dividends in 2011, $3.42 dividends in 2012, $3.56 dividends in 2013, $3.72 dividends in 2014, and somewhere around $3.82 dividends in 2015. We are talking $17.88 in cash getting sent your way. Think about how much those accumulated dividends offer protections from commodity price volatility. In 2011, Royal Dutch Shell traded between $58 and $78 per share. Even if you had the suboptimal timing of paying the highest price for Royal Dutch shares that year, the $78 per share would permit the price to fall below $60.12 before you would begin to suffer a paper loss. The low point of the recent fall came to $62.11 this past December.
And, of course, those dividends also tack on to the total returns in good times. This past summer, Royal Dutch Shell saw a high price of $88 per share. If it sees that price after the end of 2015 dividend payments, you will have total returns of $88+$17.88=$105.88 compared to the $58-$78 purchase price that we have examined.
Although this phenomenon regularly occurs in oil companies because they tend to have higher dividend payouts, it is not limited to the sector. These dividends can even provide meaningful protection if you misjudge an investment and buy at a high. I’ll use my hometown utility, Ameren UE, as an example. In 2007, Ameren UE hit a high of $55 per share. Other than hitting a high of $56 per share in 2005, this was the company’s all-time high in terms of market cap. It made $2.98 in profits in 2007, so the valuation was 19x then current profits. The company might have caught someone’s attention because people will always need electricity, but the business metrics at the time were not something to fan yourself in excitement over: earnings were growing at 2.5%, the dividend payment had been frozen at $2.54 since the 1990s, and the company had a $6 billion debt load while generating $600 million in net profit.
The business, since then, has not done particularly well: The dividend got cut in 2009 to $1.54, and has been creeping up annually since then, with the 2015 expected payment to be around $1.65. Profits stand around $2.55 per year, still below the $2.98 high earned by the company. Without reinvestment, you would have collected $13.64 in Ameren UE electricity-funded dividends since then. The price today is $41.63. If you paid the high of $55 and collected your $13.64, the price would have to go below $41.36 for you to suffer a loss today. Basically, you would have a negligible gain on your position. I find that to be a fortunate, margin-of-safety income given the inputs we used: (1) buy at an all-time high before (2) an earnings collapse and (3) a dividend cut from which the company still has not recovered.
The profits at Ameren UE are lower today, compared to 2007. The $1.65 annual dividend is lower today, compared to the $2.54 dividend payment of 2007. The stock price of $41 is also lower compared to the $55 high price paid in 2007. And yet, you are breaking even due to the power of accumulated dividends (if you had been reinvesting, you’d be even more ahead of the game).
It’s something worth paying attention to—the dividends add up over time, and can give you better returns than merely looking at the stock price or reading the headlines would indicate. Even when businesses aren’t doing particularly well, a few years of collected dividends can make it difficult for you to sustain a paper loss. Each dividend payment reduces market risk because it requires a steeper decline for you to lose your initial contribution, and focusing on this fact can help deter you from engaging in distracted selling.
Originally posted 2015-03-04 11:40:53.