For Dividend Investors, Time Pays

On
this,
Buffett
says
the
following:
“growth
occurred
every
year,
just
as
certain
as
birthdays.
All
[business
partner
Charlie
Munger]
and
I
were
required
to
do
was
cash
Coke’s
quarterly
dividend
cheques.
We
expect
that
those
cheques
are
highly
likely
to
grow”.

In
February,
Coke
raised
its
annual
dividend
for
the
61st
consecutive
year.

American
Express
is
a
similar
story.
Berkshire’s
purchases
of
American
Express
were
completed
in
1995
for
the
same
dollar
amount
as
Coke.
Annual
dividends
paid
to
Berkshire
have
grown
from
$41
million
in
1995
to
$302
million
last
year.

Both
Coke
and
American
Express
represent
approximately
5%
of
Berkshire’s
net
worth
today,
roughly
the
same
weight
as
when
originally
purchased.

Buffett
goes
on
to
compare
the
performance
of
both
investments
against
a
30-year
bond.
According
to
his
calculations,
the
purchase
of
an
investment-grade
bond
in
the
mid-1990s
in
place
of
Coke
and
American
Express
would
now
represent
only
0.3%
of
Berkshire’s
net
worth
and
would
be
delivering
“an
unchanged
$80
million-or-so
of
annual
income”.

That’s
significantly
less
than
the
$1
billion
combined
amount
that
Coke
and
American
Express
pay
to
Berkshire
annually.

Importance
of
Dividends
in
Total
Return

Generally,
increasing
stock
prices
are
the
way
most
equity
investors
think
money
is
made.
But
clearly,
dividends
can
play
an
important
role
as
well.

Since
1993,
the
S&P
500
increased
by
777%
through
the
end
of
last
year.
With
dividends
included,
the
S&P
500
increased
by
more
than
1,400%
over
the
same
period.

Dividends
alone
accounted
for
more
than
20%
of
the
S&P
500′s
total
return
during
this
period,
which
is
actually
lower
than
past
decades.

We’ve
seen
a
similar
dynamic
in
the
return
profile
of Morningstar’s
Dividend
Select
strategy.
This
strategy
focuses
on
income
generation
while
also
providing
excess
total
returns
through
capital
appreciation.
Over
the
past
10
years,
the
yield
generated
by
the
strategy
has
represented
just
over
40%
of
the
total
annualised
return.

Dividends
by
Decade

Looking
at
S&P
500
performance
on
a
decade-by-decade
basis
shows
how
dividend
contributions
varies
over
time.
From
1930
to
2021,
dividend
income’s
contribution
to
the
total
return
of
the
S&P
500
averaged
40%.

Dividends
can
provide
a
huge
tailwind
on
your
long-term
results
if
investors
diligently
reinvest
them
over
the
long
haul.

Not
All
Dividends
Are
Created
Equal

Investors
seeking
out
dividend-payers
may
make
the
mistake
of
simply
choosing
companies
that
offer
the
highest
yields.
However,
sometimes
a
high
dividend
indicates
a
dividend
cut
may
be
looming.

A
recent
example
was
Intel (INTC),
which
cut
its
dividend
66%
in
February.
Intel’s
founder
Andy
Grove
wrote
the
seminal
book Only
Paranoid
Survive in
1996.
Over
the
past
decade,
Intel
arguably
lost
its
paranoid
nature.

A
plausible
reason
for
the
dividend
cut
was
a
result
of
excess
cash
being
required
for
research
and
development
to
compete
harder
with
companies
that
have
taken
market
share.

When
seeking
out
dividend-paying
companies,
it’s
important
to
identify
whether
the
dividend
being
paid
will
be
consistent
with
opportunities
to
increase
it
over
time,
like
Coke
and
American
Express.

One
way
to
do
this
is
to
evaluate
companies
based
on
economic
moats.
A
castle
with
a
physical
moat
is
hard
to
penetrate.
A
business
with
a
moat
is
equally
hard
to
penetrate
and
more
likely
to
keep
competitors
at
bay.

Morningstar’s
Dividend
Select
strategy
has
a
strong
preference
for
stocks
with
wide
and
narrow
Morningstar
Economic
Moat
Ratings,
with
90%
of
the
strategy’s
assets
invested
in
companies
rated
as
having
a
moat.

Examples
of
Moats

Morningstar
evaluates
companies
with
moats
across
five
key
areas.

1)

Switching
Costs:
switching
from
one
business
to
another
can
be
a
costly
and
timely
process.
When
it
would
be
too
expensive
or
time-consuming
to
stop
using
a
company’s
products,
that
indicates
pricing
power.
For
example,
Fidelity
National
Information
Services (FIS) is
the
largest
software
provider
for
banks’
core
processing
function.
Essentially,
the
debits
and
credits
that
show
up
in
bank
statements
are
done
via
its
software.
Banks
are
loath
to
switch
this
mission-critical
software,
as
it
would
be
time-consuming
and
expensive.

2)

Network
Effects:
a
network
effect
occurs
when
the
value
of
a
company’s
service
increases
for
both
new
and
existing
users
as
more
people
use
the
service.
For
example,
the
more
consumers
who
use
American
Express
credit
cards,
the
more
attractive
that
payment
network
becomes
to
merchants.
This
makes
it
more
attractive
for
consumers,
and
so
on.

3)

Intangible
Assets:
patents,
brands,
regulatory
licenses,
and
other
intangible
assets
can
prevent
competitors
from
duplicating
a
company’s
products,
or
they
can
allow
the
company
to
charge
higher
prices.
For
example,
Starbucks (SBUX)
is
a
business
with
an
iconic
brand.
Last
year
alone,
Starbucks
raised
menu
prices
three
times
with
no
obvious
slowdown
in
traffic.
Its
brand
and
connection
with
consumers
are
one
reason
it
was
able
to
do
so.

4)

Efficient
Scale:
when
a
niche
market
is
effectively
served
by
one
or
only
a
handful
of
companies,
efficient
scale
may
be
present.
For
example,
Enbridge (ENB)
is
one
of
the
largest
owners
of
energy
infrastructure,
primarily
oil
and
gas
pipelines.
The
pipelines
it
operates
efficiently
serve
consumer
demand
and,
in
some
sense,
are
irreplaceable
assets.
Also,
pipelines
are
highly
regulated,
further
protecting
existing
returns
on
invested
capital.

5)

Cost
Advantage:
firms
with
a
structural
cost
advantage
can
undercut
competitors
on
price
while
earning
similar
margins.
For
example,
United
Parcel
Service (UPS) delivers
more
than
24
million
packages
a
day
in
more
than
200
countries
while
operating
an
airline,
vehicle
fleet,
and
warehousing
operation.
The
cost
of
replicating
this
scale
would
be
a
burden
for
any
new
competitor.
it
is
in
an
oligopoly
with
FedEx (FDX).
These
logistics
networks
are
simply
too
large
for
a
third
player
to
rival
them
without
taking
significant
losses.

In
a
portfolio
context,
an
advantage
of
having
an
economic
moat
is
that
it
potentially
makes
it
easier
to
manage
through
difficult
periods.
Even
in
a
recession,
companies
with
moats
can
face
it
with
a
stronger
hand,
given
all
the
levers
available.

Judging
a
Moat

While
it
may
be
relatively
easy
to
identify
a
moat,
it
can
be
more
challenging
to
accurately
judge
its
size.
It’s
even
more
difficult
to
determine
how
long
the
moat
will
persist.

For
example,
a
competitive
advantage
created
by
a
hot
new
technology
might
not
last.
The
tech
sector
is
littered
with
companies
that
go
from
playing
“disruptor”
to
being
“disrupted”
in
short
order.
Snapchat
went
from
generating
a
massive
amount
of
attention
to
becoming
an
afterthought
to
TikTok
in
a
few
years.

When
Morningstar
evaluates
a
company’s
moat,
the
first
point
of
interest
is
historical
financial
execution.
Firms
that
generate
high
rates
of
return
on
invested
capital
tend
to
have
a
moat,
particularly
if
the
returns
are
stable
or
increasing.

Yet
the
past
tells
us
only
what
has
happened,
not
what
will
happen
in
the
future.

Morningstar
attempts
to
determine
how
wide
a
moat
is
by
asking,
“will
the
moat
still
be
relevant
in
10
or
20
years?”

Take
JPMorgan
Chase (JPM),
for
example,
which
benefits
from
multiple
moats.

JPMorgan
is
the
largest
US
money
centre
bank
by
assets
and
tends
to
have
leading
share
and
operations
in
almost
all
the
areas
where
it
competes.
It
has
leading
franchises
in
almost
every
banking
product
available.
JPMorgan
is
particularly
strong
in
investment
banking,
credit
cards,
asset
management,
and
retail
household
reach.

It
has
switching
costs
(clients
who
bank
with
JPMorgan
are
unlikely
to
seek
out
financial
services
from
other
providers)
and
an
incredibly
strong
brand.

This
is
a
bank
that
not
only
survived
the
2008
global
financial
crisis
but
saved
other
banks
(Bear
Sterns
and
Washington
Mutual)
that
were
insolvent
during
that
period.
With
the
recent
demise
of
Silicon
Valley
Bank,
JPMorgan
showed
its
sturdy
foundation
providing
capital
to
regional
bank
First
Republic
Bank
(FRC).

JPMorgan’s
brand
has
a
reputation
for
weathering
storms
and
being
a
provider
of
capital
during
hard
times.
And
it’s
likely
its
brand
strength
and
relevance
will
help
it
retain
current
customers
and
attract
new
customers
10
and
20
years
from
now.

Final
Thoughts
on
the
Importance
of
Dividends

Dividends
have
historically
played
a
significant
role
in
total
return.

When
optimising
for
dividends,
it’s
important
to
consider
whether
the
dividend
is
durable.
One
way
to
do
this
is
to
evaluate
companies
based
on
moats.

Many
moats
can
be
easily
identified;
however,
figuring
out
their
width
and
depth
requires
a
deeper
look.
Moats
can
take
years
to
build,
but
if
the
company
does
not
have
the
resources
in
place
to
maintain
and
grow
them,
that
moat
could
quickly
become
a
thing
of
the
past.

“Morningstar
is
constantly
evaluating
and
attempting
to
determine
the
strength
and
depth
of
company
moats
for
inclusion
in
their
dividend
portfolio”,
says
George
Metrou,
portfolio
manager
of
the Dividend
Portfolio separately
managed
account
at
Morningstar
Investment
Management.

Dividends
are
by
no
means
a
magical
source
of
returns,
but
they
do
provide
an
edge
(or
slight
advantage)
in
a
portfolio.
By
extension,
slight
edges
can
compound
over
many
decades
and
end
up
feeling
like
magic.

George
Metrou,
CFA,
equity
portfolio
manager,
Morningstar
Investment
Management,
contributed
to
this
article

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