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 Clorox (NYS: CLX) for example. Since the late 1960s, Clorox's share price has increased 3,700%. But add in reinvested dividends, and total returns jump to 15,500%:
Source: Capital IQ, a division of Standard & Poor's.
There's no ambiguity here: Over time, Clorox's share appreciation alone has paled in importance to the power of its reinvested dividends. The results are similar for competitor Procter & Gamble (NYS: PG) ; Reinvested dividends skew 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 Clorox's dividends look? At 3.5 %, its current yield is comfortably above the market average. Dividends have been paid every year since 1968. Over the past five years, dividends have used up an average of 44% of free cash flow -- a conservative figure that leaves room for future growth and makes any impending cuts unlikely.
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 Houselowns shares of Procter & Gamble. Follow him on Twitter @TMFHousel.Click here to see his holdings and a short bio. The Motley Fool owns shares of Clorox. Motley Fool newsletter services have recommended buying shares of Procter & Gamble and Clorox. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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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