Dividends Don't Lie

By Jim Puplava
President, Financial Sense® Wealth Management

January 10, 2024

“Do you know the only thing that gives me pleasure? It’s to see my dividends come in.”
—John D. Rockefeller

“When stocks yield as much as bonds, you get the growth for free.”
—Warren Buffett

During my early broadcasting years in the 1980s, I had the good fortune to meet and interview Geraldine Weiss, often referred to as "the Grande Dame of Dividends". Her influential book, Dividends Don't Lie: Finding Value in Blue-Chip Stocks, highlights the importance of dividends in helping to provide a secure, stable, and increasing source of income, which is particularly important for retirees. Alongside the teachings of notable value investors Benjamin Graham and Warren Buffett, Weiss’ research played a pivotal role in shaping my own investment philosophy and planning process for clients, which continues to this day.

When it comes to the uncertainties of the stock market, many successful value investors emphasize the importance of dividends due to their greater predictability, unlike the unpredictable nature of timing the stock market. As I regularly remind listeners of Financial Sense Newshour, dividends offer a tangible and more certain element, as they represent actual payouts from the company, whereas a stock's future price is merely a probability or, worse yet, a possibility. As Weiss aptly put it, "Dividends represent a bird in the hand, while a stock's potential price appreciation remains uncertain."

Wall Street spends a lot of its time trying to forecast where stock prices will end the year and may often miss the mark, sometimes quite dramatically. Last year was a prime example where 7 mega cap tech stocks (the “Magnificent 7” as they are called)—Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla—drove the indexes higher, while most stocks languished behind. It is quite amazing that such a small handful of US tech companies, most of which come out of my own home state of California, could have such a dramatic impact on the stock market, and is just one example why I certainly pay attention but do not put a high degree of confidence in where forecasters believe the Dow or S&P 500 will settle at the end of the year. At this point, given tech’s dominant market share and size, a forecast about the US market is really a forecast about mega cap tech—that is, the Magnificent 7.

One thing that is much more predictable and certain however, which also experiences far less volatility over time, is whether a company has the ability to pay or raise its dividend. This is important as you move into retirement and need a steady source of income since market prices can fluctuate wildly. Thankfully, investors can have a more measurable degree of confidence when it comes to the dividends paid by Coca Cola, Procter & Gamble, or Johnson & Johnson by the end of the year. Moreover, since a dividend is a tangible payout, you can spend it, save it, or reinvest it with a lot more certainty than relying on a stock’s future price appreciation.

It is often overlooked that nearly half of the total returns in major global markets over the past century have been derived from dividends, with the other half coming from appreciation, as detailed in a book I often mention on the show called Triumph of the Optimists: 101 Years of Global Investment Returns. When you invest in a stock without dividends, your investment return becomes reliant on the unpredictable nature of the market, fiscal and monetary policies, and the fluctuating sentiments of investors. This is precisely why I advocate for the predictability and stability of dividends. Additionally, a significant advantage of the dividends received from the companies we own is that the majority of these companies consistently increase their dividends each year with a high level of predictability. This, in my opinion, also makes dividends an excellent hedge against inflation.

An important question must be asked: If you are retired, how will you cover your future expenses as inflation continues to rise each year? I am happy to report, with the exception of mining companies (more about mining companies later) the stocks we own continue to increase their dividends. The dividend increases last year were not as high as the previous year, reflecting the slowdown in the economy, but remain respectable from a low of a 3% increase to as high as a 21% increase and a 54% increase in the energy sector. Overall, excluding the mining stocks, which pay out special dividends in addition to regular dividends, overall dividend growth for our holdings increased on average 9% last year, not as good as 2022 when they rose over 11%, but still respectable in keeping us well above inflation.

A final comment on dividends before I get into particulars: dividends are taxed at a far more favorable tax rate vs interest income, which is taxed at ordinary income tax rates. Below I have listed the tax rates on dividends so you can see how much less you pay in taxes vs ordinary interest.

2024 dividend tax rates
Source: SmartAsset

There is one more qualifier on dividends, which is the Obamacare (Affordable Care Act) tax which adds 3.8% additional tax once your income exceeds $200,000 if you are single and $250,000 if you are married.

Reviewing last year, there were two sectors that stood out in terms of dividend increases: energy and healthcare. Listed below is a sample of dividend increases from these two sectors within our portfolio.

2023 dividend table

Other standouts in terms of dividend increases were GIS (7.62%), TGT (10.10%), and NTR (8.95%).

The Mining Sector

Because commodity prices can fluctuate widely, mining companies handle their dividends differently. They pay out a regular dividend which can increase, and a special dividend which is paid out when commodity prices rise and cash flow increases to the mining sector. This is a smarter way to handle dividend payouts rather than raising and lowering them constantly. For example, one of our positions, EOG, increased its regular dividend from $0.75 to $0.91, an increase of 21%. They still paid out a special dividend of a $1.00 in March and $1.50 in December, bringing their special dividend payout to $2.50 in 2023 vs $5.80 in 2022. Despite the reduction in special dividends, EOG’s cash dividend was $6.71 for an average yield on the stock of 5.50% along with a 21% increase in their regular dividend for the year.

Despite the increase in dividends, the energy and mining sectors experienced poor price performance in 2023. Energy stocks were heavily influenced by the fluctuating price of oil, which declined from a peak of around $110 per barrel in 2022 to a range of $70-$90 per barrel, briefly dipping into the high $60 range. Similarly, precious metals stocks started the year with significant growth as gold reached new highs. However, they subsequently declined, which has been a recurring pattern whenever gold surpassed the $2,000 per ounce mark in recent years, with the sudden entry of large short positions, causing prices to decline. The same phenomenon occurred with silver, where short positions reached extraordinary levels, peaking at 2,800%. Currently, the total open interest of all silver contracts on the COMEX is 233% of the amount of silver held in vaults. Furthermore, the short position represents 1,564% of the registered silver available for delivery.

In my opinion, we are someday going to see a default on precious metals delivery on the COMEX as the short positions are massive relative to actual inventories. Regarding inventory of both gold and silver, they have fallen over the last two years reflecting large scale buying by central banks and large buyers such as hedge funds, which are accumulating precious metals as shown in the graphs of silver and gold below.

Source: Bloomberg, Financial Sense Wealth Management

Finally, I want to address the issue of metals themselves compared to stocks in general. It may surprise many of you to learn that the number one performing asset in this century is gold. It went from a price of $289.60 on December 31, 1999, to today’s price as of this writing of $2034.60, a gain of over 600%. In contrast the S&P 500 went from 1,469.25 at the end of 1999 to today’s close of 4763.54, a gain of 224%.

There are many experts that believe we may witness similar gains in the coming decade. This anticipation stems from the potential devaluation of the US dollar by the United States and the possibility of the Federal Reserve resorting to the monetization of government debt, which could lead to higher inflation rates in the future. It is noteworthy that gold experienced a price of $1,200 during the summer of 2018, and as of today, it has surpassed the $2,000 mark, representing a gain of 70%. Although this performance is not as impressive as the S&P's, it still reflects a significant increase. In my opinion, the outlook for precious metals appears promising, with their best days lying directly ahead of us. One crucial note about gold and silver is that their market size is much smaller compared to stocks and bonds. Consequently, when funds flow into the precious metals sector, prices tend to see a dramatic increase. It is worth noting that the total market capitalization of all precious metals stocks and base metals companies combined is lower than the market capitalization of Apple.

My investment strategy towards precious metals is a longer-term theme of which I have scaled in and out of with varying degrees of exposure. This sector does tend to see a higher degree of price volatility and it’s not unheard of to see precious metal mining stocks move up as much as 40% in a single week. Because of this, this sector is often a haven for speculative traders and, like AI stocks today, can quickly become the dominant talk of the financial news media, something we saw transpire during the last major bull cycle which peaked in 2011. Two notable differences that exist between then and now is even though gold is trading at record highs above $2,000, it is garnering very little attention by the wider investment community. A second and more important difference, I believe, is there is far more discipline in the precious metals mining sector, and many of the metals stocks we own today pay dividends, with the royalty companies increasing dividends in the 5-7% range.

Technology Stocks and Artificial Intelligence

AI is currently and likely going to continue to be the next technology revolution. We are using AI at our firm already for a large variety of daily tasks. It is still in its infancy and, like the internet, there are many companies hoping to capitalize on this emerging technology. There will be a few winners, but mostly losers in this space just like the internet. I remember well the number of companies that went bust in 2000-2002; companies with very little in sales and no profits. I see the same hype today when it comes to AI. The winners will be the picks and shovels in AI. We own the original developer of AI, which is IBM, and it has done nicely for us. I consider it to be a long-term hold as I love the new president’s emphasis on growth in revenues vs financial engineering through stock buybacks.

We own two stocks in our portfolio which also may seem strange to own given the emphasis on dividends. They are MicroStrategy and Alphabet. MicroStrategy is a software company run by the brilliant Michael Saylor who has invested the company’s cash flow to buy large amounts of Bitcoin. Currently, the company owns 189,150 bitcoins and plans on buying more. The company’s average cost of acquiring Bitcoin is $31,168 vs today’s price of $46,984.89. The stock has nearly doubled since we bought it.

The other stock is Alphabet, which is the cheapest stock out of the Magnificent 7. They are now working with drug companies using AI to develop new drugs for which they will be paid a substantial upfront fee and a royalty on sales once the drug comes to market. Alphabet and IBM are my AI plays. If you average IBM’s dividend with no dividend from Alphabet it comes to about 2.5%, which is above the dividend on the S&P 500 of 1.49%.

Buying Opportunities and Stock Selection

Regarding my approach to picking stocks, I prefer not to chase stocks when they are experiencing a rapid increase in value due to the high level of risk involved. Instead, I typically wait for short-term adverse events that cause a significant decline in stock prices, such as an earnings miss or otherwise. This strategy has generally worked well for me, although there are instances where I may enter the market a bit early. To capture my interest, I typically look for a correction of around 25-30% in the stock price. While this may cause short-term discomfort, in most cases, it proves to be a favorable decision in the long run.

For example, I purchased Target stock—a position we still own—after their controversial store display caused the stock price to drop from $182 to $130. Subsequently, the price further declined to $107. Despite the temporary challenges, I was attracted to the company's strong cash flow, which supported dividend payments, as well as their innovative strategy of transforming the store into a mini mall with boutique sections, similar to an Apple store within Target. Additionally, Target was developing its own private label brands that outperformed competitors like Walmart and Costco. I am pleased to see that other investors have recognized the value in Target, as the stock price has now risen to $143.28.

I had a similar experience with another company we own, which is Amgen. The stock fell from $282 to $230 on an earnings miss, concerns over an acquisition, and a tax dispute. All these issues were temporary but caused the stock to fall 20%. I then bought it at $230 with a nice dividend yield of close to 4% only to watch the stock drop further to $211 before bouncing back. They also increased their dividend by 10%. Earnings as well bounced back, their drug pipeline expanded with promising late-stage clinical trials as well as delivering strong financial results. Today, the stock is at a record of $310.

One underperforming stock that we continue to hold is Walgreens, which recently announced a 50% reduction in its dividend. Despite this setback, it's important to note that Walgreens is a significant player in the pharmacy industry, with a global presence encompassing 13,532 stores, of which 9,260 are located in the United States. Surprisingly, considering its extensive reach, the market capitalization of Walgreens (WBA) is relatively small, amounting to approximately $22 billion.

In the pharmacy sector, the competition has narrowed down to two key players: CVS and Walgreens. Rite Aid, another player in the industry, filed for bankruptcy last year due to excessive debt and now holds less influence in the pharmacy space. As the population in America continues to age, the demand for prescription drugs is expected to rise. This is a turnaround situation and I believe the new Walgreens CEO has what it takes to turn this company around. This is demonstrated by strong insider buying of the stock as well as insiders owning close to 20% of the company. I have the patience of my own convictions and am optimistic about the future outcome for WBA.

Growth for Free

Currently, the effective yield on the overall portfolio is 4.15% with an increase in dividends of 9% in 2023. This means our portfolio yield is above the return of a 10-year Treasury. In the words of Warren Buffett, “when stocks yield as much as bonds, you get the growth for free.”

Lastly, I expect and will reiterate my conviction that this decade will be a roaring bull market for commodities similar to the early 2000s. In that period of time, commodity prices were driven primarily by demand coming from China and emerging markets. This decade, I believe prices will be primarily driven by supply-side factors when it comes to the large underinvestment and strict environmental pressures on the broader energy, resources, and mining complex. Furthermore, this is not just a US phenomenon but one that is global in scale, as resource mining has become heavily out-of-favor in the international community, despite the crucial importance of commodities in powering everything we do.

Along these lines, I am including a link to a recent article by Art Berman, a world-renowned energy consultant, who I will be interviewing on Financial Sense Newshour in the coming days. His article is called “Beginning of the End for the Permian.” When the Permian basin peaks, oil production in the US will begin its inexorable decline. It is one more reason why we own energy stocks, aside from their attractive dividends, along with Warren Buffett.

Until my next update, I want to thank you for your trust and patronage as a client and want to wish you a healthy and prosperous New Year!

Advisory services offered through Financial Sense® Advisors, Inc., a registered investment adviser. Securities offered through Financial Sense® Securities, Inc., Member FINRA/SIPC. DBA Financial Sense® Wealth Management. Past Performance is not indicative of future results.

Copyright © 2024 Jim Puplava