The Extraordinary Power of Dividends: Eli Lilly 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 made 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 around price gyrations, yet dividends have historically accounted for more than half of total returns.

Reinvest those dividends, and it's even greater. Take Eli Lilly (NYS: LLY) for example. Since the late 1960s, Eli Lilly's share price has increased 1,300%. But add in reinvested dividends, and total returns jump to 4,300%:

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

There's no ambiguity here: Over time, Eli Lilly's share appreciation alone has paled in importance to the power of its reinvested dividends. Total returns remain far below the peak they hit in 2000, but that owes more to the shares being overvalued back then than it does to their returns ever since. The results are similar for competitors Pfizer (NYS: PFE) and Merck (NYS: MRK) ; reinvested dividends skew both companies' total long-term returns dramatically higher. If you're a long-term shareholder, don't worry about daily share wobbles. Devote your attention those dividend payouts, and your commitment to reinvest them.

And how do Eli Lilly's dividends look? The company has paid a dividend every year since 1885, raising its payout annually since 1966. Its current yield, 5%, is among the highest you can find among high-quality large-cap stocks. Like most big pharmaceutical companies, patent expirations cloud Lilly's future earnings growth. If it's any consolation, dividends have used up just 46% of free cash flow over the past five years, leaving room for earnings to drop significantly before the company would need to cut its dividend.

Asked on a conference call last year about keepings its dividend intact amid an uncertain future, CEO John Lechleiter stayed adamant: "[W]e are maintaining our commitment to our dividend, to paying our dividend at at least its current level."

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 @TMFHousel.Motley Fool newsletter services have recommended buying shares of Pfizer. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

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