Motley Fool Money - Fool School: The Dividends Show

Episode Date: January 27, 2024

Growth companies get a lot of the glory in investing. But something seemingly more snooze-worthy is behind a whole lot of wealth creation.  Ricky Mulvey caught up with Fool analysts Matt Argersinger and Anthony Schiavone to talk about all things dividends. They discuss: Whether “special dividends” are really special at all.  2 “Dividend Knights” – and a Cincinnati grocer that may rejoin the same ranks. Why investing is not just about revenue growth. Get your dividends report here: www.fool.com/2024dividends A correction: Texas Roadhouse serves lunch on the weekends. Dividend Knights link: https://docs.google.com/spreadsheets/d/1-OPCz9pXOcgFqmbMR3wxREg4O7ws_qWW8RWqKPYn1D4/edit#gid=0 Tickers discussed: TXRH, KR, DDS, SCHD, VIG Host: Ricky Mulvey Guest: Anthony Schiavone, Matt Argersinger Producer: Mary Long Engineers: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

This episode is brought to you by Indeed. Stop waiting around for the perfect candidate. Instead, use Indeed sponsored jobs to find the right people with the right skills fast. It's a simple way to make sure your listing is the first candidate C. According to Indeed data, sponsor jobs have four times more applicants than non-sponsored jobs. So go build your dream team today with Indeed. Get a $75 sponsor job credit at Indeed.com slash podcast. Terms and conditions apply.

As an investor, you don't have to go out there and find the company that's growing its revenue the fastest. Someone's going to look at Dillard's and say, wait, the revenue's like flat or down. Why am I, why would I even think about investing in this company? And you sort of ignore the idea of what's happening underneath the surface at the bottom line, capital allocation, what management's doing. And you can ignore a lot of great, wonderful investment stories by doing that. I'm Mary Long and that's Matt Argersinger, senior analyst at The Fool and a lead advisor on our dividend investor service. Ricky Molli caught up with Matt and Anthony Chavone to dive deep into dividends.

They discuss the case for making dividend stocks the focus of your portfolio. What makes some dividends particularly special? And how line dancing and free bread rolls have made a market beater. Anthony Chavone, Matt Argusinger, always good to catch up with you and talk about dividends. I know this is a topic you're passionate about and one that honestly we don't talk about on the show enough. So thanks for being here. You bet, Ricky. I have to be here.

Of course. All right. So we'll kick things off for newer investors because we're still in January and this is when people are getting interested in investing. And there's a lot of big stories about these huge, growthy companies, but set the table with maybe the long-term case for the dividend paying stocks. Sure. So I think when most investors, especially newer investors, when they think about dividend stocks or

companies that pay dividends, their immediate thought is, okay. well, great. This is a company I'm going to invest in. It's paying out a quarterly or regular dividend. And it's all about income, right? That's kind of what I'm going for. I see a stock. It's got a 3% yield or great. But, you know, okay, if I'm looking for income, that's all fine. Our arguments, though, are that it's actually, it's the place you really want to focus. whether you're a new investor or old investor, investors who's going to retire or even investor who's 25 years old and just looking to build capital because it turns out, there are a lot of studies that support this, but one that we kind of go back to Anthony and I and Anthony actually found this data a while ago and its data from the Hartford funds and Ned Davis research. And it goes back and it looks like the S&P 500. So the biggest market index out there looks at all the components of the S&P 500 going back to 1971. or 1973, sorry, and it broke it down and looked at all the companies in the index and companies that paid dividends, companies that didn't pay dividends, and how they performed over this long, 50-year stretch, right?

And what it turns out is that if you look at the average stock in the index, the average stock in the index went up about 8% over that time span. The companies that paid a dividend, though, went up over 9% on the analyzed basis. Even more exciting for us. Companies that grew their dividends consistently, though, increased over 10%. And the amazing thing is, you got better returns from companies that were paying dividends or growing dividends with much less volatility than the rest of the market. So it's a smoother ride.

You get income along the way and you're outperforming. To us, it set so many light bulbs for us, and it's why we started a dividend service here at the Motley Fool recently. But it also just totally, for me, reframed how I approach investing and what, I'm I'm looking for when I think about the core of my portfolio. The core of my portfolio today is dividend growth companies. And that was not the case just a few years ago. But Matt, let's say I'm a young company.

I can't afford to pay this dividend because I have too many growth opportunities to invest in. And this is the sign that I'm really growing. Right. I'll say one thing. I'll pass over to Ant because he's got some interesting data on that. But even younger companies, Ricky, should think about paying a dividend because as it turns out, companies, even small companies, growing companies, great companies, large companies. Companies don't actually do a great job, believe it or not, of reinvesting their capital. We think of

companies like, well, there's Apple. Look at the great examples. Microsoft, Alphabet, Starbucks, right? These companies, well, of course they should retain their capital because they've earned such high rates of return for so long. Turns out that's really hard to do. And there's only a small, very small number of companies that can actually do that. And as Ann's going to talk about here, companies actually are better off paying a lot of their earnings out in dividends. And there's some interesting reasons why. Yeah, I think that's probably one of the most overlooked part of dividend paying companies is that when companies pay a dividend, the constructive tension that the dividend puts on the

management team is pretty impressive. So say the company pays out like, say, 50% of its earnings, that management team really needs to make sure that the capital that is getting reinvested into the business is going towards the highest returning projects. And conversely, the company is generating a lot of cash and they're not paying out a dividend. You're essentially, as a shareholder, you're placing a lot of faith in the management team to reinvest that capital at a high rate. And it not engage in foolish behavior, like making a large value-to-shoring acquisition. And to that point, I actually came across a study from AQR Capital Management called Surprise.

Higher dividends equals higher earnings growth. And the study's a bit dated. It took place in 2003, but it contains 130 years worth of data. Ultimately, what they found was just that. When a company pays out a higher percentage of its earnings as dividends, future earnings growth tends to be higher. And conversely, when a company pays out a low percentage of its dividends, future earnings growth tends to be lower.

And so some of the main reasons that the study cited was that major teams tend to pay out more when they have an optimistic outlook on the business. Since they're paying out a large portion of earnings, They're forced to be more prudent when allocating capital. So that's the long term. And right now, things are a little bit different than they were just a few years ago. Interest rates are higher. You can get a treasury bill that's paying four to five percent a year.

We've seen that hit companies like Charles Schwab. I can even get, I can get debt funds. You know, I never thought I'd be looking at bond funds, Matt and Anthony. But here I am. I even bought a few of them because they're going to pay. And this is diversified across a bunch of companies. they'll pay you, you know, six to eight-ish percent. Right.

No, I agree. The paradigm is certainly shifted. And I think that's a really great point to bring up. So we are living in a world of higher interest rates. And wow, yeah, it's cool, man. You can get, you know, 5% on the money market, 5% Treasury. And these are risk-free, quote, risk-free instruments. So why in the world would I look at a dividend-paying company, which has all the risk

for to get a 3% or 4% yield, a lower yield? And my argument there, my best argument would be when you're buying a company or investing in a company that pays a dividend and it's a good company, that company's going to be able to grow that dividend over time. And that dividend you're getting is probably going to be protected by inflation and probably going to grow, it's going to vastly exceed inflation if you're finding the right companies. And you just can't get that in a T bill or in a bond, right? It's a fixed payment. And even though those yields look really great today, I would still argue that with dividend paying companies, you're getting growth, getting that inflation protection. You're taking

on a little more risk, but as we've seen throughout going back many, many years, that risk is well, well worth it. All right. Let's get into some of the filters that we use to find dividend paying companies that are growing those payments back to shareholders. We've talked about it on the show before, and I think you came up with it a few years ago, but I want to reintroduce it to listeners who may be less familiar to the concept of the dividend nights. Maybe they've heard of the dividend kings, the dividend aristocrats, but the dividend nights, Matt, a little bit less familiar. So walk us through. What's it take to be a dividend night and maybe your thought process of putting it together? Sure. Well, this was Anthony and me maybe trying to come up with

a more foolish version, more motleyful version of the dividend aristocrats or dividend kings, achievers, all those more popular labels. And so we came up with this dividend knight's idea. And I think the reason we came up to it, the reason we like it is because if you look at, say, the dividend kings, which is a very impressive list of companies that have raised their dividend 50 or more consecutive years. I mean, that's, it's remarkable. But oftentimes, a lot of companies on that list will stay on the list by raising their dividend, a fraction of a cent even in a given year to, you know, so they can actually claim, well, we raised our dividends. We still, we're still dividend king, even though, you know, the dividend went up a paltry amount. And so we said, well,

what if we focused instead on the degree by which companies are growing their dividend? So not just by, you know, one percent or one cent, but let's say what about companies that grew their dividend at better than 10% per year? And not only that, what about companies that beat the market as well? So not just stodgy dividend companies that are slowly raising their dividend over time. We want companies that are beating the market and raising their dividend at a double-digit rate. And so those are the core tenets of the dividend nights. And for us, it's become an awesome source of new dividend-paying ideas.

Because if you think about a company that's over the last 10 years, that's the time frame we use, over the last 10 years has not only beaten the market, but raised its dividend at a compound annual rate of more than 10%. Well, that company is doing a lot of things right. And so it behooves us to study that company and figure out what's going on there and maybe recommend it. So that's kind of why we're so excited about this dividend night's concept. Anthony, I'll kick it to you. Are there any companies, any members of the Knights that maybe you want to put the spotlight on? Yeah. So I recently did some boots on the ground research and went to Texas Roadhouse, ticker symbol TXRH. I went there for dinner one night and it was pretty awesome. Great atmosphere. They had line dancing, which is kind of unique

at a casual. That's what really drew in the first place. He was the line dancing, but that was a passive voice sentence. There was, you either want, did you watch line dancing? Did you line dance yourself? I watched it. I watched it. But anyways, the food was awesome, especially the free rolls they give out as soon as you sit down. And it was super affordable. So I decided to do some more research into Texas Roadhouse, which is a dividend night. And a company is pretty impressive.

So they own 722 restaurants primarily in the U.S., but they also have some international locations too. Their dinner only, they do zero national advertising, zero limited time offers, and they currently have zero debt on their balance sheet. And I thought this was pretty impressive. So since their IPO in 2004, they've grown their revenue and earnings per share every single year, except for 2020 when their restaurants were forced to shut down because of COVID. And I just looking at this dividend growth, it's grown as dividend by 16% over the last decade.

And that even includes a dividend cut during the pandemic. So, yeah, I think Texas Road has a pretty interesting one to keep on your watch list. I think it's a little expensive right now. But maybe investors will get a break in the future. And I'll just add, yeah, the stock itself is up almost 400% over the last. last 10 years. It's crushed the market. I mean, I'm not sure a lot of people would think of Texas Roadhouse as this powerhouse little restaurant company, but certainly has been. That's actually something I think, I don't think we talked about it with the dividend nights list

that I liked is it does give companies the flexibility to cut their dividend for a little bit if they need to. So what you mentioned with the Kings and a lot of the aristocrats list, you have to, like, maybe it's actually not in a company's best interest who pay a dividend for a couple of years. You think of Vail Mountain Resorts in 2020 when they have to shut everything down for the pandemic, but because the rules you get kicked off the list, and that gives them a little bit of flexibility. Exactly. We love, yeah, that's why we're focused on just the growth of the dividend, not the, not necessarily the frequency or the consistency of it. I'll also, I'll throw in a company that has recently got kicked off the list. Anthony, I know you follow it.

It is the grocer Kroger, which was there for, it was there for a while when I checked last time, no more Kroger on the list. I think it's, it's because it's not really beating the market anymore. had a lot of pricing power over the pandemic. Sales have dipped a little bit. There's a big question mark about whether or not it will merge with Albertsons. Anthony, what do you think it's going to take for that Cincinnati Grocer to get back on the dividend nights list? Yeah, I think it's going to take some type of resolution to the Albertson's Kroger merger. I think there's a lot of uncertainty around that right now. But I think either way, once that gets resolved, whether the FTC allows the deal to go through or whether they ultimately shut it down, I think just,

that certainty will allow the market to move forward with Kroger. You talk about Kroger, I mean, just a massive company, and really their competitive advantage comes down to their scale. The operate 2,700 stores. That's going to be around 5,000 stores if the merger closes. Their average store has about 80,000 SKUs. They have about 430,000 employees. So this is a super complex business, and they only get razor-thin margins. So it's super difficult business, but ultimately their scale is really kind of their competitive advantage, helps them to leverage their distribution and advertising costs. So I think, once we get some resolution to this merger, I think it'll be better for

Kroger moving forward. Right. And I think that scrutiny has been so interesting because they're already saying they're going to divest a certain number of their stores, a significant number of their stores actually to get this merger done. But even after the merger goes through, they're a distant second, like a distant second to Walmart in terms of grocery sales. And so I'm trying to figure out why it's getting so much regulatory scrutiny, especially,

you know, especially since they are divesting kind of in certain markets. So it's not as going to be as a complete a merger as, you know, as sort of originally designed. Yet it's the process here is taking forever. And I just don't see why that's the case. I think there might be some pressure. little bit more of a administration that is hungry to stop a lot of large mergers. There might also be some political pressure from the grocery prices that people are paying. So it's a sensitive topic where it's not a secret that grocery prices have gone up. And even for a company like

Kroger, the margin, like sales have declined over the past year, but the margin has gone up. And I think that might capture some folks' attention. I'm going to concern troll a bit on Kroger because I worry it might, you know, I'm a shareholder, so I'll start with that, but I worry it could be like a utility where it passes that snap test. People would immediately recognize if Kroger was not there, it would be, it would be ruinous. But maybe it's not a market beater over the long term, and it's only paying me about 2.5% to wait. Yeah, I don't think Kroger would ever be a high growth business.

And it probably, well, never will be. I don't think. So I think it's labeling as a utility or some type of infrastructure companies is definitely reasonable. I would just say that this current valuation around 10 times earnings, you know, between gives it the market beating potential. I mean, between dividends and buybacks, management aims to return around 5 to 6% of the company, the shareholders each year. Then if you look and you get 3 to 5% earnings growth each year, the total return starts to look, you know, around high single digits, low double digits. And then with it trading at 10 times earnings,

you know, maybe you get a little bit of multiple expansion, then maybe you're looking at a market beater. There you go. I want to move on. Hold those shares, Ricky. Hold those shares. I'm holding. I'm holding. I'm not selling. I want to move on a topic. I don't think we've done on a previous podcast. And that is one level down on basically when you Google a company and you see their dividend pay out. And that is the special dividend. So a few months ago, Costco announced that it was paying a $15 special dividend to shareholders. Setting the table, why, you know, why do companies pay out special dividends? What is the strategic capital allocation reason? It's an interesting question. And it's funny that here in the U.S., we call them special.

Because we're very unique to other developed market economies and stock markets. In the U.S., we have a culture and tradition where companies tend to pay regular dividends, quarterly, semi-annual, sometimes annual dividends. And shareholders get kind of used to that. A company will declare the dividend. You know, we're paying a 15 cent dividend in a month. And then we're likely going to pay that same dividend three months from now and so forth. It kind of goes on. We get used to that.

But then now and then, a company like Costco or another company will come out and say, well, okay, well, not only are we continuing to pay our regular dividend, we're going to throw in a $15 special dividend. And it's like, wow, that's incredible, amazing shareholders feel good about that. This is actually common practice in a lot of European or Asian stock markets. And that's because a lot of those companies will tend to tie their earnings, or sorry, their dividend to their earnings. And so if a company has a good year for earnings, they have excess cash flow, they declare a dividend that's appropriate to that level of cash flow. In the U.S., we could do it kind of differently.

So it's more of a surprise. It is more special. But I think a company like Costco does it absolutely right. You have a regular dividend. Investors get used to that. It gets management that discipline that we talked about earlier about we have to pay this dividend every quarter. But in times when in good times, when we have excess cash flow and we want to share more profits with our shareholders, we're going to pay a special dividend as well.

And Costco tends to do it pretty regularly. So their special dividend is almost becoming a regular dividend. And I think it's important when it is a company like Costco, factor that into your yield, factor that into your return expectations, right? So you might look at Costco's regular dividend yield. It might look pretty paltry. I think it's less than 1%. But if you factor in those special dividends, it's got a much higher yield.

over time. It's also a specific choice for management for, we'll focus on the American companies, to not buy back shares and pay out those special dividends, especially when you have companies doing a mix of both. Maybe they're saying, you know what, in our view, these shares aren't undervalued. Right. No, I agree. And I would say we could do a whole show on buybacks. And if you ask Anthony to me, we're so much more in favor of dividends and special dividends because management teams, like they reinvest capital, they tend to buy back their shares at really bad times as well. And so a good mix of both, if you can find a company that does a good mix of both, maybe

an emphasis on the dividend and buybacks are more of the infrequent capital allocation choice. That tends to be the right mix from our point of view. I got a company that's buying back a lot of shares in about 30 seconds. But when you guys, so you guys focus on dividend paying companies, are the special something you hunt for? or is there something where maybe investors can find companies that are a little bit better about paying these special dividends, especially when it's not as visible on that surface level search when you're looking at a company on Google and it shows up as a paltry dividend, but you may not

know that they're paying out 15, 20 bucks a share on a regular basis? That's a good question. Yeah. It's not something that I put in, it's not a big part of my process. In other words, I'm sort of focused on the regular dividend because I like to see the history and the growth over time. And the special dividends kind of tend to distort that. You can't really get an easy gauge on, okay, well, if they paid a special dividend one year,

then we had three or four years to do the next one, is that really something I should factor into my return expectations for the stock? It's a little wonky. So it's not something, to me, it's still a bonus. You can find a company like a rare company like Costco that does it both, it does it really well. That's kind of a bonus to the research. But generally, we're focused on regular dividends.

All right. Well, I want to talk about a dividend. night that we don't talk about on the show that I've been dying to talk about. So, Matt, I appreciate you signing up to talk about Dillards with me. That is the mall department store that sells. It's a big clothing store. And it is, it's kind of a survivor in terms of anchor stores at the mall. E-commerce didn't kill it.

And e-commerce is not a big part of its business. This is another one where I'm a shareholder of. I have a small position. And here's the story. It's a family-run company, a ton of inside ownership, very little short-term debt. enough cash to pay off its entire debt load, long-term debt load. It's not a revenue growth story, but what they're trying to do is basically pay a lot of special dividends to the employees, which own a lot of stock in Dillards through their 401k plan,

and also the Dillard's family, which I would assume likes receiving those special dividends. You have some ownership, at least as of 2021 from Ted Wexler, who's on the Berkshire Hathaway team. I don't know. Give me your take. Shoot some bullets in my arguments on Dillard. I don't know, no bullets here. Maybe Anthony has some bullets. But I am just amazed by this story. But this is a story, believe it or not, that I think would be, you know, if you said, if you told someone, you know, one of the best performing stocks over the last five, 10 years is a, you know, a department store in a mall, you know, in mostly southern Midwestern states, right? I think most

people would just know there's no way, right? But that is true. But this is actually something that's a little more common in companies that we tend to follow. And that's because take a company like Altria, just to use a bad example. But there's a company, you know, Philip Morris International that the, or sorry, the Philip Morris brand, cigarette brand. Revenue hasn't grown at all. In fact, revenue is declining. Just like Dillards, you said it's not a revenue story. I was looking at Dillards. There are five year, sorry, no, 10 year revenue change. The 10 year revenue change, this is cumulative for Dillards, 3%. In other words, the revenue. It was only 3% higher than it was 10 years ago.

But then look at the normalized earnings per share of 540% or the last 10 years. A lot of that's because of buybacks, by the way. Look at the stock price change, 340%. Look at the dividend change, 320%. So this is a company and a management team and a board that made a decision a while ago. It's not about revenue. It's not about opening new Dillard stores because there's not a great future for that.

but it's about maximizing the efficiency and operations of our existing stores and allocating a ton of capital to our employees and our shareholders and just see if we can have this profitable business that generates great returns and look at it. Look what it's done. And there are a lot of examples of this actually and why Anthony and I will tend to preach this, but as an investor, you don't have to go out there and find the company that's growing its revenue the fastest. If someone's going to look at Dillard's and say, wait, the revenue is like flat or down,

Why would I even think about investing in this company? And you sort of ignore the idea of what's happening underneath the surface at the bottom line, the capital allocation, what management's doing. And you can ignore a lot of great, wonderful investment stories by doing that. So I would say, it's not always about finding the fastest growing companies that companies that can grow their sales the most. The companies have the biggest market opportunity in something like AI or something, right? You can find some amazing investing investments.

Digging in the service, looking at companies that just simply are allocating capital well. Well, and to your point, that's because it's not necessarily about revenue. It's about total shareholder return. And while I know, while I know y'all aren't a huge fan of the share buybacks, Dillard's has executed it to a tremendous degree over the past. They've more than half their shares. They're very interested in buying back their own shares. It's also a, it gives you a 5.5% dividend yield over the past year if you include the special. So if you look at the, if you look at Google Finance, it's less than a percent. But they're very much, and this is relatively new within the past few years, paying 15, 15, 20 bucks a share back to. their shareholders, which, you know, aligns you with the management a little bit. Exactly. And you mentioned the buybacks. I'll just point out last 10 years, shares outstanding for Tillards down 63%. So they've bought back 63% of the business over the last 10 years. Amazing. And I will say one thing it has in common with Altria, excuse me, both are trading at less than nine times earnings, excuse me, single digits there. Right. We have focused on, we focused on individual companies,

but building a portfolio of dividend paying stocks, you don't necessarily need to just pick companies. There's a lot of ETFs you can get. And I like dividend ETFs for sort of the defensive part of my portfolio. And maybe this is good for helping someone else invest in your family. Maybe they don't like picking stocks. I know this is something that's happened recently for you, Matt. Let's talk about some of the dividend ETFs. Excuse me.

Are there any you want to talk about or any that you have used personally? So one that I've followed for a while and invested in is the U.S. Schwab dividend equity ETF. The ticker is SCHD. And it's got a great track record. It's for up until about a couple of years ago, it was handily outperforming the market. And then it's just, you know, recently with the rise of the rebound of the NASDAQ and rest of the market, it's fallen a little bit behind. But it is a wonderfully managed ETF. It really focuses on high quality dividend paying companies that, that can grow their dividends over time. And recently, we decided to roll over one of my wife's old 401ks to an IRA. And, you know, rather than, and it was a big lump sum, and rather than try to kind of invest in individual stocks, which would take a while, and this was the end of last year, I said, you know, one of the, one of the ETFs that I love that's really lagged that I think is going to, you know, is going to have a great future is the Schwab dividend equity ETF.

And so I said, you know what we're going to do? we're going to take 50% of this new IRA and we're going to put it right into the Schwab ETF. It's, and we'll think of it as our sort of core dividend index of this, of this IRA that we're just going to invest, hold, reinvest the dividends over time. And then with the rest, we'll probably buy some individual stocks. But I wanted that to be one of the core investments of that new IRA. I'll say one more or two, if you're interested in dividend growth specifically, and we talked

a lot about that in the show, and it's our preferred strategy, there is the the Vanguard dividend appreciation ETF, VIG, VIG, and it also has a pretty good track record. And there you're focusing, you'll see, you know, with that ETF, you'll see a smaller yield because it's investing in companies that are trying to grow their dividend fast rates over time. So, and that also has really done well as well. So that's just another, you know, again, another low cost big ETF, dividend ETF that's out there that you could invest in as well. Matt Argusinger, Anthony Chavone.

They also work on a service at the Motley Fool. You can guess what it's about. It's called Dividend Investor. Appreciate your time and talking about investing with me on this Saturday. Thank you, Ricky. Always a pleasure. Nice, Ricky. If you enjoyed this show or are interested in learning even more about dividends, we've got something for you. Some of the Motley Fool analysts behind Stock Advisor, our flagship investing service, have put together a list of three dividend stocks to buy this year. We're sending the report to Motley Fool money listeners for free just as a thank you for checking out the show. No purchase necessary. Go to fool.com slash 24 dividends and we'll email the report directly to your inbox.

We'll also include a link in the show notes. As always, people on the program may have interests in the stocks they talk about. And the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.