Historically, investors have purchased stock with the expectation that a portion of a company's annual profits would be distributed to them as a return on investment. Typically, an established company will reinvest a portion of their earnings back into its business, repurchase some of its outstanding stock, and then will distribute the rest of the earnings to stockholders in the form of dividends.
Walsky Investment Management, Inc. seeks out companies with strong dividend growth potential as the principal holdings of its managed portfolios. Most often, these companies have a history of dividend growth well in excess of the rate of inflation.
Our analysis has found that stocks with annual dividend increases not only hold up well during periods of volatility, but also act as a critical element of portfolio growth. Companies that increase their dividends regularly are relatively stable, competitively produce products and services needed by the public, maintain a strong presence in their markets, and are well managed. They have records of consistent earnings growth and adequate cash flow to easily cover their dividend and expansion needs.
Although many companies pay dividends, only a relatively small number of them have maintained dependable dividend growth. These are the equities we seek for our managed portfolios.
The term "total return" is used when expressing the performance of stocks. When measuring performance, total return is the actual rate of return of an investment or a pool of investments over a given evaluation period. Total return also includes the reinvestment of dividends over the period. According to a recent study by Ibbotson Associates, from the end of 1925 through the end of 2005, large company stocks such as those included in the S&P 500 Stock Index had a compounded annual growth rate of 10.4%, including capital appreciation and reinvested dividends. If dividends are eliminated from this calculation, the annual growth rate of large company stocks was only 5.9% for the same 80-year period. By themselves, capital gains were only marginally better than the returns of long-term government bonds for the same 80-year period. The power of dividends is clear.
Our view is that strong dividend growth stocks are long-term performance achievers with lower risk and volatility than non dividend-paying stocks. Dividends, we believe, are very important in the creation of wealth.