The Extraordinary Power of Dividends: Pepsi Edition

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I took my first investing class as a teenager, and one moment stands out in my memory. A fellow student asked the instructor, a stockbroker, about dividends.

"Dividends?" he asked. "I'm trying to make my clients wealthy. You don't do that waiting for tiny checks in the mailbox every quarter."

Even then, I had enough horse sense to know he was wrong. Paying attention to dividends is exactly how you become wealthy over time.

Wharton professor Jeremy Siegel shared a wonderful discovery in his book The Future for Investors. The greatest long-term returns typically don't come from the most innovative companies, or even companies with the highest earnings growth. They come from companies that happen to crank out dividends year after year. Simply put, since the 1950s, "the portfolios with higher dividend yields offered investors higher returns."

Market commentary regularly centers on price gyrations, yet dividends have historically accounted for more than half of total returns.

Reinvest those dividends, and it's even greater. Take Pepsi (NYS: PEP) , for example. Since the late 1960s, Pepsi's share price has increased 8,900%. But add in reinvested dividends, and total returns jump to 23,400%:

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Source: Capital IQ, a division of Standard & Poor's.

There's no ambiguity here: Over time, Pepsi's share appreciation alone has paled in importance to the power of its reinvested dividends. The results are similar for Coca-Cola (NYS: KO) and are beginning to skew higher for newly public Dr Pepper Snapple (NYS: DPS) . If you're a long-term shareholder, don't worry about daily share wobbles. Devote your attention to those dividend payouts and your commitment to reinvest them.

And how do Pepsi's dividends look? The company has not only paid, but also raised, its dividend every year since at least 1972. At 3.1%, its current yield is comfortably higher than the market average. Over the past five years, dividends have used up an average of 55% of free cash flow -- a conservative figure that leaves room for error as well as future dividend-growth potential. Pepsi has been one of the great dividend stocks to own over previous decades, and it should remain so for more to come.

To earn the greatest returns, get your priorities straight. What the market does is less important than what your company earns. What your company earns is less important than how much it pays out in dividends. And what it pays out in dividends is less important than whether you reinvest those dividends.

At the time this article was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter at @TMFHousel.The Motley Fool owns shares of PepsiCo and Coca-Cola. Motley Fool newsletter services have recommended buying shares of PepsiCo and Coca-Cola and creating a diagonal call position in PepsiCo. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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