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Total Return
#1
It seems like every time I log into Seeking Alpha there is an article that DGIs are doing it wrong, since they are not looking at the true measure of investment progress, which is total return.

I don't understand this mania for total return. Given that total return is the sum of capital gains and dividend income, the only time total return has any relevance is when you sell a stock.

The key problem is that capital gains are unknowable. You can not plan for capital gains. An unrealized capital gain is meaningless if the stock price falls tomorrow. Even the historic long term trend of capital gains is in jeopardy due to baby boomers selling stock to fund their retirements, increasing cost of resources used by the industrial revolution, and other issues with American business (such as the curtailing of employee training). I am not trying to be a Debbie Downer, but capital gains is not a slam dunk. My personal assumption for investments is that capital gains will be sufficient to cover inflation.

Another issue I have is that capital gains are being emphasized at the top of a bull market. This is illogical to me. Isn't this the time when income should be emphasized?
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#2
A lot of people are planning on selling their portfolio at some point: most likely liquidating it slowly at a few % per year during their retirement. In that case it is total return that matters, not only dividend income. Now if you plan on leaving all of your portfolio as inheritance then you can worry about dividends and leave the capital gains as the worry of your children. But even in that case, total return will make a difference in their lives.

I too emphasize dividend income since it is something that is fairly predictable, whereas capital gains are not. But that doesn't mean that I completely disregard capital gains either... even though I don't think I will ever sell my shares.
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#3
(05-24-2015, 08:20 AM)KenBob Wrote: The key problem is that capital gains are unknowable. You can not plan for capital gains.

Planning for capital gains isn't much different than planning for dividend growth. Capital gains over the long term is a structural consequence of growing earnings and dividends in a functional market. I think a better question would be, why would you want to ignore it?

I would agree with the argument that, in the context of long term compounding and reinvesting, people who have trained themselves to look at investments only from an income perspective and ignore capital gains are taking an overly puristic approach.

Dividends are just one form of capital allocation. A dollar paid out as a dividend is not subject to market valuation, i.e. at risk of being worth less than a dollar, or at risk of being wasted. However, a dollar reinvested in the business, while put at risk, has the potential to return more. Money reinvested in business growth is necessary for economic growth and dividend growth. In fact, cash paid out as dividends arguably destroys shareholder value due to opportunity cost if there are alternative uses that could have high internal returns.

I consider myself a recovering dividend growth investor. DGI is a great way to learn about investing and is a perfectly good strategy, and still forms the basis of my approach, but it can also be a narrow strategy. A holistic approach is to consider the value of all forms of capital allocation (dividends, buybacks, growth spending, acquisitions, and deleveraging). True, this type of growth is subject to market valuations, economic cycles, and your ability to sell higher. But in a functional economy and a functional market, business growth will be valued appropriately because institutional investors won't leave money lying around in the street.

A good example of a total return investment that I own is UNFI. United Natural Foods is a distributor of natural and organic foods and other supermarket items, with Whole Foods as its largest customer. The company has been expanding at about a 15% annualized rate for at least a decade. UNFI doesn't return anything to shareholders via dividends or buybacks, because all their money is better spent building more distribution centers, hiring employees, leasing trucks and expanding their service territory, as well as making small acquisitions. If they hadn't spent their money on growth, they would have missed a 15% internal return so far, and shareholders would have paid the opportunity cost. If they had stayed small and paid dividends instead, and you had reinvested those dividends, you would have surely made a lower return. You would also own a less stable business today.

When the growth runway slows, UNFI will start returning cash to shareholders. They mentioned in a recent conference call that they see about two more years of reinvestment in the business before they start diversifying their capital allocation strategy. If and when they start returning money to shareholders, it will be a lot more money than if they had remained a small business. The intrinsic value of the shares has gone up over the last 10 years because of their growing underlying cash generation.

The stock market could correct and UNFI shares could crash, and I would have nothing to show for it. This would be a buying opportunity because ultimately, the company makes money and therefore has intrinsic value to owners.

The portion of the earnings not paid out as dividends should compound internally at the rate of RoE or RoI (this is still a bit fuzzy to me) in a way that only management has the ability to do. The part of earnings paid out as dividends will not earn those returns; that is now your money and your responsibility.

A growing dividend is a sign of a strong business, real earnings, an anchor on the price, and an important part of total return, but it is not always the best form of total return, and not the only way I want my money spent.


Edit: I should add that in 30 years or so I plan to start rotating out of total return and into yield, hopefully during years when I can tuck my capital gains into the lowest tax bracket.
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#4
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#5
I think the problem is people see their way as the best. That's rational. However, many think because it's the best for them they are rude enough to tell you that you're wrong for not agreeing with them. I think DGI is best for me and is the only investment method that made logical sense to me of all the things I tried over the years. Therefore, it is psychologically easier for me to stay the course. Since this is the Dividend Growth Forum, that's the way I reply to posts.

I also think DGI can produce decent total returns. It's a matter of the choices you make. I would not consider investing in T for total return but having them pump 5ish% in dividends into my account every year sure does things for cash flow.

As I said to notexactly over in this this thread:

Quote:You have two things pushing up prices over time.
  1. Increasing earnings: The type of companies we are talking about have the tendency to keep increasing their earnings. Sure they have slumps and rough periods. Some are internal causes and sometimes it's the economy, stupid. Sometimes it can take several years for a company to work out their internal problems but dividend growth companies do have the ability to bounce back. Afterall, the dividends have to be supported by their earnings. No one is going to let KO's price drop or stagnate to only 5x earnings without something catastrophic happening.
  2. Increasing dividends: Like wise, as the dividend increases, yield will keep going up for a company with a stagnant stock price. You will never see JNJ yielding 10%. Someone will buy them out long before that happens.

I think dan's reasoning for investing in UNFI makes perfect sense for him at his age and where he is in the investing lifecycle. For me it holds no interest right now. Yet I invested in GILD for the same reason. I had a hunch a dividend was not in the too far future but there was no guarantee at the time. Ken, I agree. Price is much more uncertain than a seasoned dividend payer's payout.
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#6
Imo total return is the only relevant measure as to overall investing success. Selling shares for cash flow is little different than spending dividends. In one case the company pays out earnings as dividends and in the other case the share price appreciates because of retained earnings. if a company is retaining 10% earnings per year, in theory one could liquidate say 5% of the shares each year and never touch the principal. How is that any different than if the same company chose to divert 5% of its 10% earnings to a dividend which the inestor spends. In either case spending the 5% is a withdrawal of capital from the investment. Also in either case as long as earnings cover the withdrawal, the value of principal will likely remain intact.

The good thing about DGI is that dividends are growing and earnings are also growing. If the pay out ratio is low, then lots of retained earnings contribute to growth of capital. Therefore most DG candidates should also be pretty good total return candidates as well.

I think that the conflict between dividends and total returns mostly comes into play when yield chasing via low growth stocks which have high pay out ratios.
Alex
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#7
When I was in my 50's I worried if I would have enough money to retire. In my 60's I was concentrated on trying to build the pile, buying and selling and trying to match returns I did not understand or made much sense.

By trying other investment strategies I could never accomplish what others seemed to be able to do so easily.

It wasn't till I started concentrating on the income my investments could generate that investing made sense. It got me away from buying and selling, looking for quick gains, panic attacks when prices dropped and trying to project future price gains.

I've pushed that concept (generating income, rather than gains), especially to those with limited funds to invest or those who don't want to work at investing. Could one do better, very likely and that's a credit to their abilities.
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#8
Yes, but income that the company generates is relatively more important than the investor income that their dividends generate. Take a long time DG stock PBI for example. Earnings started to slide, the business became less relevant, eventually dividends were cut. Obviously DG growth investors focus heavily on total return, even if that is not a conscious activity. If they are watching the earnings performance of the company and they are watching the pay out ratio, in additional to the dividend growth rate, then they are also monitoring major components that will contribute to total return. Like I say, most DG stock are in fact good total return candidates. Perhaps one could do better long term by focusing on pure growth, but DG represents a good balance between dividends, capital gains, and total return.
Alex
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