Look around your home. What kind of stuff do you own? What are the services you pay for to keep things running?
Do you have cleaning products from Proctor & Gamble? Where do you shop for groceries, personal care products, and other household items? What provides your utilities, cable, and internet?
Your answers to these questions comprise what economists call “Consumer Staples.” These are things that we don’t necessarily love to spend money on. In fact, you may either take these things for granted or become almost annoyed every time you have to ante up. But, these are the goods and services we need to keep our homes running.
Now, consider the things you own that many would consider luxuries or pleasure items. We’re talking about automobiles, electronics, clothing, entertainment and the like. This spending falls into a category known as “Consumer Discretionary Goods.”
As a consumer, it’s essential to understand where you are spending your money – necessities or nice-to-haves. As an investor, it’s also important to know where your investment dollars are going.
In the world of index investing and Exchange-Traded Funds (ETFs), do you know what companies you have bought into? And, is your investment basket too broad or carrying too many unknown components?
In 2010, there were close to 4000 stocks in some of the Vanguard Total Stock Market Index Fund. You can buy one ETF and own a piece of almost 4000 companies. But the market has experienced some shrinkage in the last nine years. Now, there are only 3600 companies in the pool. That’s because many companies have undergone mergers, bankruptcies, and takeovers, and there’s recently been a reduction in Initial Public Offerings. Still, that’s a heck of a lot of businesses.
I want you to consider the idea that there’s value to investing in the products you must re-buy regularly. As Peter Lynch (one of history’s most successful stock investors) famously said, “The best stock to buy may be the one you already own.”
As a bonus, there are no management costs associated with owning stock in individual companies. So, take a look around and see what you find.
The simplest way to get a feel for your cash outflow is to comb through bank and credit card statements and companies you have set up on automatic bill pay. Once you’ve gone through this process, identify the top ten or 20 places your hard-earned money is going.
It pays to know. Many of your primary vendors will lead you straight back to publically traded companies.
Now, you may be new to the world of investing. Or, you could be a seasoned veteran who already prefers to own specific companies rather than mixed baskets investments. If you’re not already doing so, consider putting some money into the companies that have their hands in your pocket. If this is already part of your investment strategy, then I challenge you to look for even more opportunities. After all, these companies are already getting a portion of your wallet share.
As an illustration, I recently made an index of my family’s Top 13 Consumer Staples and Consumer Discretionary Goods.
Here is our index, in no particular order:
- Amazon (which includes Whole Foods)
- AT&T (which includes what was Time Warner)
- Walt Disney
- General Motors
- Dunkin Brands
- Southern Company
These are the companies that feast on my family’s income. So, I know where my cash is going.
Here’s the icing on the cake: All of these stocks (except Amazon) pay out healthy dividends. And, many of them have raised their dividend payouts over time. If those dividend checks are reinvested, they can quicken the growth of your total portfolio. However, it is important to understand there is no guarantee dividends will continue at any particular level and changes in the economy will impact future returns.
“Dividends don’t lie,” is a favorite bit of wisdom among financial advisors. For a company to pay a dividend, it has to have the money with which to pay it.
A business’s earnings can’t be some accounting sleight-of-hand; there must be money available. So, while we investors can’t know everything about the companies we invest in, one thing is for sure: If a company pays a dividend it has the cash-on-hand to pay it.
And we all know this other truism: It is very difficult (if not nearly impossible) to make your retirement work for you solely in cash. If you stuff everything you save under a mattress, you’ve got to account for inflation and taxes. With this view, you see this is a very limiting way to “invest” over time.
Both of these concepts taken together should offer some encouragement for the investor who is looking at dividend-paying stocks. Markets may dip and drab, or they may soar to new heights, but they are always plowing new ground.
My argument is bolstered by a study called “Portfolios Formed on Dividend Yield,” by Eugene Fama and Kenneth French.
Fama and French separated stocks into groups based on the dividend yield. Various stocks were assigned a number using a one-through-ten method. In their approach, a ten would have a very highest yield, while a one would have no yield at all.
The study then took stocks in groups seven, eight, and nine (all above-average yielders) and analyzed their data back to 1937. It’s important to note that they didn’t use the very highest earners, the tens. That’s because, most of the time, if a stock is yielding an extraordinary amount compared to everyone else, they’re likely not as stable. No one wants to end up being sucker-punched at the end of the day, right?
So, any idea what the two researchers found? Those above-average yielders, combined with capital appreciation, resulted in more money at the end of the day for investors. This finding was true during three-to-five year rolling periods more than 70% of the time. And, for ten-year rolling periods, it was true almost 85% of the time.
Fama and French’s study confirms the conclusions of other pieces of research on the same topic. It’s been previously shown that dividend raisers and initiators, on an equally-weighted basis, wallop the steady dividend-payers, non-payers, and dividend cutters, to the tune of 12.5% growth (versus 10.5% in the latter group).
Now, you and I both know “if past history was all there was to the game, the richest people would be librarians,” as Warren Buffett has so astutely commented. But there is something to be said for historical market trends, and investments that periodically pay you cash that you can continue to reinvest. To me, that’s a recipe for excellent growth potential.
But, think of what we can learn from history about dividends. And, while you’re at it, don’t forget to take a look inside your own home and driveway.
So, consider adding these two critical pieces of financial insight together and go forth; put together your own household’s Consumer Staples and Consumer Discretionary Goods Index. No doubt, it will be littered with companies that we know and love. These companies often pay those juicy dividends as they continue to evolve, reinvent themselves and innovate. However, there is never a guarantee and any investment decision needs to be discussed with a financial professional and a portfolio needs to be diversified to help mitigate risk.
These are the companies I take a shine to – the ones that end up on my family’s index. What’s on yours?
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Disclosure: This information is provided to you as a resource for informational purposes only. It is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal. This information is not intended to, and should not, form a primary basis for any investment decision that you may make. The information contained in this piece is not considered investment advice or recommendation or an endorsement of any particular security. Further, the mention of any specific security is solely provided as an example for informational purposes only and should not be construed as a recommendation to buy or sell. Always consult your own legal, tax or investment advisor before making any investment/tax/estate/financial planning considerations or decisions.