The Extraordinary Power of Dividends: Northrop Grumman Edition
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 Northrop Grumman (NYS: NOC) , for example. Since the late 1960s, Northrop Grumman's share price has increased 2,500%. But add in reinvested dividends, and total returns jump all the way to more than 12,000%:
Source: Capital IQ, a division of Standard & Poor's.
There's no ambiguity here: Over time, Northrop Grumman's share appreciation alone has paled in importance to the power of its reinvested dividends. The results are similar for General Dynamics (NYS: GD) and Lockheed Martin (NYS: LMT) . Reinvested dividends skew both companies' long-term results 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 Northrop Grumman's dividends look? At 3.1%, its yield is comfortably above the market average. The company has paid a dividend every year since at least 1989. Doing most of your business with the federal government comes with advantages and challenges. Having a customer that is seemingly indifferent to frugality is a plus. Relying on one customer that has overspent in recent decades and will be driven to cut back in future ones could pose a problem. Over the past five years, dividends have used up just 30% of Northrop's free cash flow. That's low by business standards, and it leaves considerable room for error should earnings turn south. On recent conference calls, management reiterated its commitment to shareholder value by returning cash through dividends.
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.
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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 General Dynamics, Lockheed Martin, and Northrop Grumman. 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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