The Extraordinary Power of Dividends: Eaton 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 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 Eaton (NYS: ETN) for example. Since the late 1960s, Eaton's share price has increased 1,000%. But add in reinvested dividends, and total returns jump to over 5,000%:

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

There's no ambiguity here: Over time, Eaton's share appreciation alone has paled in importance to the power of its reinvested dividends. The results are similar for other industrial companies like ITT (NYS: ITT) and Parker Hannifin (NYS: PH) ; 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 Eaton's dividends look? The company has paid a dividend every year since 1923. Dividends per share have grown at an average rate of 8% for the past quarter century. At 2.8%, its current yield is slightly above the market average. Over the past five years, dividends have used up an average of 40% of Eaton's free cash flow. That's a conservative figure that keeps its payout relatively safe from cuts and leaves room for future dividend growth.

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 thisarticle was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel.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.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.