Build Portfolio Wealth With Total Return Value
Build Portfolio Wealth With Total Return Value
Why and how total return investing best serves quality-driven value investors
Summary:
High-yield dividend stocks and dividend growth investing were all the rage in the post-Great Recession bull market for all the wrong reasons.
Thoughtful, disciplined, and patient investors are steadfast to dividend value investing or total return from capital gains and dividend income.
Mistake number one for many investors is buying into an investment based on a tip from a broker, financial writer, or worse, a neighbor. Do your research.
A profitable alternative to high-yield investing is calculating the yield-on-cost of quality companies with low payout ratios already residing in your portfolio.
Instead of chasing yield, buy quality at a reasonable price and hold for as long as possible, perhaps forever. Any dividend payouts are a bonus.
Chasing dividend yields and non-dividend growth are recipes for junk. Build wealth with total-return investing — capital gains plus income — thus, in retirement, we pursue bucket list items instead of higher dividend payouts.
I rebalance our family portfolio perhaps once a year — by adjusting the holdings to maintain asset allocation — driving it as a total-return vehicle instead of one of income only. Remember, dividends keep us compensated in the short term as we wait for capital appreciation of the stock over time.
This post explains why and how total return best serves thoughtful, disciplined, and patient quality-driven value investors.
Practice Total-Return Investing
Quality dividend value investing, or total return, focuses on dividend yields below 5 percent, a range where companies pay far lower than 100 percent of earnings in dividends, also referred to as the payout ratio, addressed later in this post.
Many companies behind 6 to 10 percent and higher-yielding shares must grow dividend rates, or the stocks need to fall in price, or a combination thereof, for the dividend yields to remain high or increase. Those are recipes for disaster.
It is rare for popular trends to become remedies for struggling investors. Time and again, each investment fad is harmful to portfolios. Common sense investors favor companies where the average of trailing dividend yields plus the yields on earnings and free cash flow exceed the prevailing Ten-Year Treasury rate. Nevertheless, we cannot predict the future accurately and never attempt to do so at the expense of our portfolio and the family it supports.
Although safer than high-yield dividend or non-dividend growth investing, dividend-paying value investing carries the shared risks of investing in the stock market. All dividend stocks face unexpected rate reductions or suspensions by the company’s board of directors.
The dividend-paying common shares of quality companies tend to be less vulnerable to ticker price volatility and market liquidity than forward high-yield dividend or non-dividend growth stocks.
All the Rage for the Wrong Reasons
High-yield dividend stocks were top-of-mind for investors starving for higher payouts in the low-interest-rate environment of the post-Great Recession bull market.
Many top subscription offerings and financial media pieces focused on the forward high-yield paradigm. History tells us the crowd is almost always wrong regarding fads and favorites. High-yield dividend stocks — defined as 6 percent and higher yields on common shares — are no exception, and that is why QVI maintains a perpetual bearish view of the practice.
Along with high returns, loom risky headwinds and questionable underlying fundamentals. Just ask the victims of the high-yield junk bond bubble in the 1980s. Perhaps the recent bull market and its high-yield equity opportunities are different; the perma bulls rejoice.
The junk bond craze returned to the recent bull market through forward high-yield dividend stocks. And history reminds us how that bubble burst during the 1987 stock market crash. This time, instead of leveraging mergers and acquisitions at the corporate level when available capital was insufficient, high-yield equities influenced daring risk/reward plays as retail investors and advisors sought outsized returns to leverage retirement account balances.
Defining high-yield equity is debatable and broad. Therefore, this post distinguishes high-yield dividend stocks as publicly traded equities distributing at least one-and-half times the prevailing Ten-Year Treasury rate that stood at 4 percent as of the market close on July 6, 2023. Hence, we arrive at 6 percent or higher as our arguable definition of high-yield equity.
Consider the sub-1 percent rates an anomaly in the epic bull market context. An inevitable cyclical downturn in the overall stock market preempts the principal capital invested by millions of retail investors concentrated in risky, high-yield dividend equities such as business development companies [BDCs], master limited partnerships [MLPs], and real estate investment trusts [REITs]. This time, the coronavirus pandemic and inflationary bear market reared their ugly heads and pummeled many high-yield portfolios.
Disciplined investors never buy stocks based on market euphoria or the dividend yield alone.
His Neighbor Yelled, “Buy the Yield”
For some background: High-yield dividend investing appeared on my radar earlier in the post-Great Recession bull market from a retired family member.
Acting on a tip from a neighbor — mistake number one — he moved a substantial amount of capital from a well-known, blue-chip equity REIT to the unpriced, non-marketable security of a high-yielding hotel REIT.
The REIT staple sold out to create the capital ended up a seven-bagger stock with an approximate range of 4 to 5 percent in average annual dividends in the subsequent years. As promised, the unpriced hotel REIT paid much higher dividends, and the security, in due course, went public at about the original cost per share.
On the precipice of the COVID-19 coronavirus correction, the price of the now publicly traded hotel REIT was down 15 percent since the IPO, although it continued to pay healthy dividends. It was a preliminary result in the scheme of things, as it equated to a no-bagger, in stark contrast to the seven times return of the blue-chip REIT sold to create capital for the high-yield, unpriced security.
The misfortune of the family member is an example of the risks involved with unpriced securities. However, priced or unpriced, the persuasion of retirees to sell below 5 percent stable yielders for the 6 to 10 percent plus forward yields of risky equities was widespread. Again, caveat emptor prevails.
The enticement of high yields on a stock seems to overshadow the necessary due diligence required to determine if the representative company is stable enough to justify the yield with capital allocations and shareholder returns from a well-managed operation. Do we prefer to own a quality 4 percent yielder with compounding average capital gains of 6 percent a year or a high-risk stock yielding 10 percent, although averaging a minus 5 percent annualized capital loss?
Quality-driven value investors are averaging a plus 10 percent average annual total gain in the former. In contrast, the high-yield fan is settling for a meager plus 5 percent average annual total return.
Perhaps some retirees have had the opposite experience by investing in high-yielders producing double-digit total returns each year during the recent bull market. Like a raucous party, this bubble burst when the coronavirus pandemic arrived uninvited. High dividend investors who think it possible to time the perfect exit are sailing on the proverbial ship of fools.
Chasing Yield: A Recipe for Junk
Many top financial advisors, bloggers, and investors focus research and investing energies in forward high-yield dividend investing, such as REITs, BDCs, and other closed-end funds (CEFs), energy transfer partnerships, and preferred stocks.
For those wondering, QVI invests exclusively in common shares, whereas preferred stock is an equity instrument presented as a glorified bond emphasizing the dividend. Despite holding no voting rights, preferred shareholders are paid some earnings before the common shareholders. However, if we are committed to owning tiny slices of quality companies, there is less worry about getting in line for payment.
Thus, take the secondary dividend and the first voting rights — and, more importantly, the capital gains — of the common shares of high-quality, enduring companies.
Some well-crafted story headlines and marketing pitches cast a positive spin on the paradox of a safe, high-yielder. Such absurdity is akin to fishing for sushi-grade salmon in a crystal clear river known as toxic from a colorless pollutant.
As expected, these pundits remind us of what we missed, disregarded, and tripped over in the amateur analysis, challenging some of our assumptions and conclusions. Although the professional debate is encouraged and welcomed, QVI’s premise remains that investors chase dividends more than enterprise quality with forward high-yield stocks. Nonetheless, if a conscientious trading strategy puts income ahead of capital gains, so be it with cautionary best wishes.
Remember, dividend rates adjust monthly, quarterly, or annually from board-directed payouts. The corresponding yields go up and down each market day as a prisoner of the stock price. The concept of dividend payouts involves a simple paradigm in the fundamental economics of the price/yield relationship, whether bonds or equities.
The yield goes down when the price goes up, and vice versa.