Even though I spend a lot of my time thinking about and writing about dividend-focused strategies, I’m definitely not opposed to strategies that involve focusing on profit growth in general without much consideration of the dividend. How can I criticize people who have been holding Berkshire stock for 30+ years? They are more financially successful now than I will ever be. I don’t want to throw stones at people who are better than I am at investing.
But I do think there is an appeal in having cash come your way on a regular basis, organically through the profit sharing structure of dividends at the high-grade American companies. If you accumulate 25,000 shares of Philip Morris International, you are going to collect $94,000 in dividends (plus you pay taxes). That creates options for you–without working, you get to live on the salary of the average American household (low $50k’s) and you get $20,000+ coming your way each year to fund new investments. If you want to spend your life being a capital allocator, it seems to me that income investing is the way to go.
Why? Because it constantly gives you cash, which is the “raw material” to make new investments. If you owned 17,826 shares of Berkshire Hathaway instead of Philip Morris International, you don’t benefit from the growth until you decide to sell. There’s no $94,000 in dividends; yeah, you are the beneficiary of having Warren Buffett make capital allocation decisions for you (which is one of the best places in world history an investor can be), but it is up to you to work and come up with cash from your labor to get that $50,000 to live on and that additional $20,000 or so to invest. It doesn’t come your way automatically, you have to show up somewhere eight hours per day to earn it. There’s no automatic, passive introduction to your life; if you want cash to show up in your accounts, you gotta go out there into the world, grind it out, and work for it.
But the person with those 25,000 shares of Philip Morris International has a life hack that makes going through life (1) easier, and (2) more fun. Even without doing anything else, that $94,000 in Philip Morris International dividends will grow to over $100,000 with the next dividend hike, as long as the Philip Morris Board of Directors sees hit to hike the dividend in line with the company’s earnings per share growth.
What are the implications of this? If inflation runs at 3-4% annually and Philip Morris International “automatically” gives you a dividend raise of 8-10%, then you can either upgrade your standard of living (that’s what happens when income growth is greater than inflation) or you can have even more money to make new investments.
And, of course, if you choose to invest $20,000-$30,000 worth of your Philip Morris dividends each year, then they are going to be paying out dividends of their own. Picking up 400 shares of Royal Dutch Shell instantly adds another $1,440 to your household’s bottom line, and those dividends should, in turn, grow as well with time. It’s one huge self-propelling cycle that transforms your life once you get the right infrastructure in place.
A lot of people have the worldview that, in the name of tax efficiency, you try to purchase as many low dividend stocks as possible and then wait until retirement to convert them into the “typical” dividend stocks. That type of thinking discounts the fact that companies like Exxon, Coca-Cola, Johnson & Johnson, Pepsi, and Chevron have superior earnings quality and bring about life-changing growth in their own right, if you put enough money into your starting investment and give it enough time.
Once you have a stable of the best companies in the world sending you dividend checks your way, the 20% or so that you have to send to the taxman becomes nothing more than a minor irritant (and dividends don’t get taxed at all until you hit the 25% ordinary income tax rate, and they are at 15% until you hit the 35% rate). The options that keeping 80% or so of the dividend payment, in addition to the near perpetual 7-10% automatic growth in income without taking into account reinvestment, obliterates this disadvantage.
Worrying about the taxes on dividends is an example of trying to be too clever to the point that you cease to engage in smart behavior. Without taking taxes into account, Chevron turned a $10,000 investment into $2.1 million over the past 44 years. Assuming the worst taxation possible during those years, you’d still have around $1.5 million. That $10,000 was worth about $40,000 in purchasing power today. Even with inflation and taxes, you still increased your purchasing power 37.5x in 44 years just by recognizing that Chevron was one of the most dominant energy enterprises on the planet. If you paid your taxes out of pocket along the way, you’d be collecting $192 every day, just for waking up in the morning.
If you sold Chevron shares to make your tax payments, and spent the entirety of the 44 year period in the highest tax bracket, you still turned a $10,000 investment into something that would pay you $137 per day. Your dividend yield-on-cost would be 1.37% PER DAY. And the crazy thing is that you didn’t have to do anything other than come up with the initial $10,000 to invest; you didn’t have to strategy against Exxon, drill for oil in the deep seas, launch projects in Nigeria, convince government regulators to let you operate, or install safety equipment. You were the passive owner that got to go about life doing as you please. There are very few honest ways to get 8-10% annual growth in income projects without doing anything beyond paying taxes and staying alive, and yet, but being a common stock owner in the San Ramon, California oil giant has been one way to combine seed capital with time in such a way that you’d be making more money just for waking up in the morning than being someone who wakes up at 6:30 AM, showers and brushes his teeth, sets out for the next ten hours, and then draws the average American salary.
If you have the infrastructure in place to be bringing in enough income to live on plus make new investments automatically, then there is detriment in purchasing something like Berkshire Hathaway or Chipotle (the fast-growing restaurant company with absolute nothing negative on its balance sheet–no pensions, no preferred stock, and no debt). If you have enough to live on and make fresh investments, then there is no hardship to buying something that requires you to eventually sell to realize a profit. That is because you already have the lifestyle in place that you want; nothing is being given up while you let the investment grow until you choose to sell.
The point is, what kind of life do you want to create for yourself that is going to be achieved by investing? If you load your portfolio with Berkshires and Chipotles, you either have to sell the stock or keep working in order to maintain your lifestyle and continue to invest. You have to keep the same workweek in place from your labor to advance forward. But the end game of dividend investing is different: as the cash flow increases beyond your labor (and it will if you stick to this stuff long enough), then eventually the end game is a zero hour workweek where the automatic income from your high-grade holdings provides for your lifestyle and you have more money coming in so that you can purchase even more high-grade securities that will automatically add even more money to the cash deposits that hit your bank account. Dividend investing is about style almost as much as substance. You get to choose the road that appeals to you.