Thursday, August 10, 2006

Dividends: Swinging the Odds in my Favor!

In my own investing, I pay attention to signs that the business managers and corporate directors have a "shareholder orientation". One place this is clearly visible relates to dividends; paying and increasing them. The reason I pay attention is because the propensity of dividend-paying stocks to outperform is well-known. As reported over here, dividends have a fabulous track record for indicating outperformance with the underlying stock.

Some have speculated that this is due to the managers having to keep their "eye on the ball", i.e. what produces cash-flow and earnings, and to look to keep developing aspects of the business able to do that. I believe that's true over the longer-term.

Over the shorter-term, I also believe that instituting or increasing dividends has a good record of predicting upturns in that particular business. Basically, when either of those things happens, a group of individuals very knowledgeable about the business (i.e. the company's directors) are telling you that things look pretty good from their perch.

Generally, they're going to have far more knowledge and insight about their business than I do, and when you add that to the obvious shareholder orientation of returning excess capital, this provides me with three positive signs unavailable in many businesses. Just to recap, those signs are:

1. Ability of management to keep their eye on the ball - i.e. business activities that generate cash;
2. A "report" of sorts from the directors, that things are looking pretty good as far as they can see, and;
3. A "shareholder brain", a positive decision to return excess cash to shareholders, rather than spend it foolishly.

I once used a list published in a national newspaper that showed companies that had increased their dividends in the past one, three, and five years (i.e. three sets of companies) by the highest amount over that time frame. I think each list had about 50 companies on it, with some overlap (i.e. a company might have appeared on two or even three of the lists). Many were obviously larger companies with established track records and with very solid, if unspectacular, share price growth too.

However, I used the list in a different way. I speculated that companies appearing only on the one year list (highest dividend raises in the past year) and nowhere else, were signalling a significant upturn in their business fortunes.

I tracked those companies, let's call them Dividend Dynamos, over the course of a year, and compared it to the most appropriate benchmark, the TSX/S&P60.

Even after eliminating those in the oil business (whose fortunes were in a major upswing) from the Dynamos, but not the benchmark, after one year, the 10 remaining Dynamos were up by an average of 39%, compared to just 18% for the benchmark. Also, not a single one of the Dynamos was up by any less than 20%!

Further, a quick and dirty assessment on the benchmark told me that about half of the benchmark rise was due to oil companies. So the true comparison was even starker: about a 4:1 advantage for the Dynamos.

Dividends: a good thing. Look for them.

NB Ammended at 10:04AM to include missing link to prior dividend discussion. Also here.


The Confused Capitalist


quints said...

Great post. I would like to thank you for the insights you share on this blog. I have always been a trend-following investor but am looking to branch out a portion of my assets into value and your posts show you know how to do so successfully!

Jay Walker said...

Thanks quints,

accolades always appreciated!


Anonymous said...

Where did you find the information regarding the dividend increases for 1,3, and 5 year periods?

Great site

Jay Walker said...

The dividend increase list was from an article in Canada's Globe and Mail, published about November 2004. The writer was Rob Carrick.

Jay Walker
The Confused Capitalist