Dear Valued Clients and Friends,
I am writing this week’s Dividend Cafe from Reagan International Airport in Washington, DC. I recorded the video and podcast from my hotel room last night. I am soon departing for Memphis, TN where I am speaking at a conference Friday and Saturday before returning to New York. I was in DC to speak to a very large group of college students at George Mason University on free market economics. I had taken the train into DC yesterday from New York after my flight to DC on Wednesday got canceled just minutes after speaking to a symposium in south Orange County on the ESG investing movement (you can guess what perspective I brought to the subject). I made it to that conference after having a flight from New York Monday sit on the tarmac for four hours waiting for fuel. So from New York to California back to New York to Washington DC to Memphis then back to New York again, all in six days. It’s been a week.
I generally give about one speech per month, somewhere (not counting the speeches I give to my kids, which have an entirely different audience both in quantity and enthusiasm level). This week I gave four in one week. I guess there is something about 90-degree temperatures and 90% humidity that really screams “conference season!” I look forward to normalization beginning Saturday night.
In the meantime, I scrapped plans for a Dividend Cafe on plans for the American supply chain and what those changes may mean for the American economy, and instead have elected to do a refresher on dividend growth. I plan to do a “dividend growth” focused Dividend Cafe once a quarter, and this seemed like a pretty good day to do it. Not to brag or anything, but I can write a Dividend Cafe about dividend growth quite intuitively (which I guess bragging about that would be like bragging about one’s speech and debate achievements in high school to the football team, which I will just anecdotally mention is not as cool a thing to do as it may sound).
But do not feel ripped off! These are very fresh ruminations about dividend growth (I do not pull old editions from the files, ever), and they are crucial. Sometimes I feel that every issue of Dividend Cafe should be about dividend growth! The “re-shoring, on-shoring, near-shoring” discussion will come to Dividend Cafe very soon, and in the meantime, today’s edition will scratch the appropriate itches.
Dividend growth is, after all, the very end to which we work.
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First and perhaps foremost
One of the things I wish I reiterated more about dividend growth investing is the mentality change it ought to accompany. This is not to say it always does in the mind of the investor. But from the vantage point of the investment managers (i.e., us) it certainly does, and for investors/clients capturing the full essence of its overwhelming benefits, it behooves them to adopt this mentality difference.
What is the mentality of which I speak? It is concerning oneself (at least primarily) with the income the portfolio is creating more than the resale value of the holdings at a point in time.
If the resale value is up at a point in time and you are not selling everything to pay legal bills or hospital bills or pay off a bookie or buy a boat, that re-sale value is, shall we say, immaterial.
If the organic income growth of the portfolio is suffering, disrupted, or broken, you should be concerned. If it is suffering while the resale value is up, you should still be concerned. That is counter-intuitive for a lot of people. Dividend growth investors need to have their intuitions aligned with logic, reason, and self-interest. And in this case, dividend income going the wrong way while prices go up is bad.
But of course, the idea of a dividend growth portfolio is that the income not go down. Dividends should be increasing if the objective of the portfolio is dividend growth. And so if the advisable mentality for a dividend growth investor is to not be happy when re-sale prices go up despite dividends going down, what is the implied logic when inversed? Re-sale values also do not matter when they are declining, as long as no immediate liquidation for paying off a kidnapping ransom is required, and when dividends are growing one should be quite happy (provided they are growing sustainably and at the desired pace, etc.).
Counting chickens before they hatch
This is more than just a “don’t worry about market volatility” point. That is reasonably good advice for any long-term investor. But this is actually a very important point about the actual investment strategy that has been adopted:
Re-sale prices in public equities go up and down for a whole lot of reasons in the short term unrelated to reality, disconnected from company fundamentals, and immaterial to your objectives as an investor. Long-term, prices reflect the discounted benefits of cash flows you will receive. If the cash flows are coming, growing, and real, the prices will follow. The up and down prices (yes, both above and below the line of discounted cash flow reality) on a day-to-day basis are NOISE. The dividends are reality.
Let’s try some analogies. We should not get excited as Laker fans when LeBron James puts his jersey on; we should be excited when he scores (and appears to be healthy and in a good rhythm on the court). We should not be excited when a candidate is polling well 18 months before an election; we should be excited when they win an election. I could go on and on, but the point is that in a perfect world, all prices reflected in public equities are supposed to be future expectations of cash flows. We know it does not work that way in the short term – sometimes they reflect the fact that a large ETF sold a huge block of stock to meet a redemption for a client who lost a gambling bet, and sometimes they reflect a 23-year old with a Robinhood account who is showing off for friends by buying high on his app.
Two choices
Prices matter when you need to sell, but along the way, the dividend growth investor knows that everything they are doing is centered around the generation of sustainably growing cash flows. Therefore, they have two choices:
(1) Focus on what things center around – what matters – what they care about – what they are actually after: The generation of sustainably growing cash flows. Or …
(2) Focus on what cannot be controlled, cannot be anticipated, cannot be known, and cannot be analyzed rationally or coherently -short-term price movements.
A chart of the price movement of a portfolio shows a backward look at all the times other things that don’t matter happened.
A chart of the value of the organic income generation of a dividend growth portfolio shows the actual thing you care about and how it really did.
The mentality of the latter ought to be our focus. The mentality of the former too often is.
The business of business
I intensified my appreciation for dividend growth investing when I more intellectually embraced the distortions that public market reality was creating. At the end of the day, companies in public markets have stock prices and those stock prices trade, often hundreds of millions of shares per day, but it is a COMPANY, not a stock. It is a real BUSINESS. Good things happen for the business each day, or maybe bad things do some days, but the stock price is not reflecting those things second by second because it often doesn’t even know about them. Likewise, I own a business – and things happen some days that are good and other days that are bad. But never in my wildest dreams would I think, “oh no, XYZ happened today, and if I were to run out and sell my business in the next five minutes it might be worth a tad less.” Likewise, I have never thought, “ABC just happened, and it is good, and that means the business is worth more.” Things happen to every business, every day, that impact cash flows, and good operators are running improving businesses and bad operators might be running deteriorating businesses, but why in the world would we think of these things in the context of resale value?
The fact that public market equities provide unfathomable liquidity does not change the fact that we own a business, and the health of that business is reflected in its cash flows over time. Period. We know this with private businesses and act like it isn’t true with public ones. The dividend growth mentality fosters more enlightened focus.
What do I lose?
If my point here were to say, “Over time your portfolio will do worse than alternative ways of investing, but with dividend growth, you don’t have to care about it.” that would be one thing. But that is absolutely not what I am saying. In reality, the dividend growers have performed better than the entire market in every long-term period I have ever analyzed and done so with less portfolio volatility. I talked about this in the mid-year Dividend Cafe a couple weeks ago. I have no idea what price movement will be for the index in the years ahead or for dividend growers. I do know that the mentality we have not only doesn’t know nor forecast, but it also doesn’t care.
And that has never come at a cost over the long term, using history as a guide. But of course, “past performance does not guarantee future results.”
Fringe benefits
If all I ever got out of dividend growth investing was a superlative future income that grew over time I would be very happy. I actually get a few other things, though, that have to be included in the story:
(1) I get more income than just the income produced by what I initially bought. I get that income buying more of that which produces the income (dividend reinvestment) between now and when I need the income so that when I take the income, it will be higher than that generated by my initial investment because I compounded my way to a higher base of income production (think of it like using rent checks from tenants to buy more apartment buildings, meaning you get more apartment buildings providing more rent checks).
(2) I get a tax rate that is less than half of the ordinary income rate and identical to the long-term capital gain tax rate.
(3) I get a strong tendency for management to operate the company to responsible financial metrics, avoiding the M&A, expenses, and debt levels that bring down otherwise good companies all the time.
(4) I get an investment that compensates me for the risk I have taken to be an investor every ninety days, not at some to-be-determined date in the future. In other words, I modestly de-risk every quarter.
(5) If I were taking income from the investments (as roughly half of clients do), I would get to insulate my withdrawals from the impact of market volatility, providing a market-price-level-agnostic way of monetizing my investment.
(6) I get to give myself a raise every year as income grows year over year. I will add that it is not “fixed” income, which is incredibly impressive truth-in-advertising.
(7) I get a strategy that historically, in the most severe of distress moments, has not exacerbated panic at the same level broad markets have (see Chart of the Week right below).
(8) I get valuations that do not reflect excessive momentum, froth, euphoria, and speculation but rather a category of investments that is generally priced in a stratosphere of reason and sense.
I could go on and on – the fringe benefits exceed the #8 … But there will be more opportunity for elaboration in future issues of the Dividend Cafe!
Chart of the Week
For those whose view of history is limited to their adult lives, note the last three drops of note for the broad market – dot com (2000), the GFC (2008), and the most recent bear market (2022). A 10-20% lower drawdown for dividend growers per incident is noteworthy.
Quote of the Week
“The elevator to success is out of order. Go one step at a time.”
~ Fred Trump
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I hope the refresher on dividend growth was beneficial for those of you who have heard it all before, and I hope there was some new revelation in there somewhere for all of you. If you are new to dividend growth, I hope this opens up a mentality change.
That mentality change is a portfolio-changing, life-changing gift for those who get it.
To that end, we work.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
dbahnsen@thebahnsengroup.com
The Bahnsen Group
thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
