If I had to offer up one major criticism of dividend growth investing it’s that it can often take on too literal an interpretation. Don’t get me wrong, paying special attention to stocks that have managed to increase their dividends in each year over the past ten, twenty or thirty plus years will lead you to a treasure trove full of amazing companies. But the downside is you can end up with huge opportunity costs that are totally unnecessary if you apply it too literally.
The most obvious example of this is when folks dump stocks from their portfolios because of dividend freezes. Of course it may be the case that a freeze is a harbinger of something really bad, but as a hard rule it’s just far too rigid and short-termist. Take the experience of Hershey (NYSE: HSY) during the financial crisis for instance.
In the decade leading up to 2009 Hershey shareholders saw earnings per share rise from $1.05 to $2.17 (adjusting for one-time charges) and the dividend rise from $0.50 per share to $1.19 per share. The actual shareholder returns over this period would’ve been quite poor though as the start and end points coincide with periods of historically high and low valuations respectively. The January 1999 share price of $31 corresponded to a forward price-to-earnings ratio of 26.3 compared to a January 2009 price-to-earnings ratio of around 18.
Let’s say you decide to part ways with Hershey in December of 2009. That’s the month that the company paid out their fourth quarter dividend and was the date in which shareholders knew for certain that there wasn’t going to be a raise that year. The state of play at that point was a $36 share price – which is only 16% above what it had been at the equivalent point in 1998 – and a frozen dividend to go with it. Oh, and it just so happened to coincide with the market turbulence from one of the worst financial crises in the modern economic period.
With that in mind you might be tempted to justify a decision to sell off Hershey stock at the point. If you were a dividend growth investor the freeze might well have been the kicker in persuading you to dump it and seek out pastures new. However in doing so you were effectively dumping the stock at around 18x annual earnings and with a 3.3% dividend yield. Doesn’t sound particularly special does it? But there’s a good reason why the average price-to-earnings ratio over the last couple of decades is around 21x earnings: Hershey stock at a fair price is a great long-term investment. Remember, whenever you see someone in the checkout line throwing down their dollars for a Hershey’s bar or a packet of Reese’s Peanut Butter Cups then about 10% of that purchase is flowing straight to Hershey’s bottom line. It’s about as solid a business a you’re ever likely to come across.
Consider what shareholders who stayed with it experienced in the years since in terms of business performance and investment returns. They have gone from collecting a $1.19 per share dividend in 2009 to collecting $2.402 per share in 2016. Overall in the intervening period you saw a total of $12.078 per share paid out in cash dividends. In addition you’ve seen the chocolate profit machine go from pumping out earnings of $2.17 per share in 2009 to around $4.30 for 2016. Finally, you’ve seen the share price rise from $36 to $105.
There’s another good reason why I said that Hershey stock at a fair price is a great investment. Check out the income side of things when you reinvest dividends. In 2009 you start off collecting $1.19 per share in dividends, and so for every 1,000 shares you own that works out as $1,190 in annual income. By the end of 2016 those 1,000 shares have morphed into 1,180 shares courtesy of automatic reinvestment, and the initial dividend of $1.19 per share has also grown by 10.5% a year to $2.402 per share by 2016. When you crunch the numbers that means your initial $119 in annual income would now be $2,830.44. That’s equal to a pay rise of 13.15% a year since 2009. Not too shabby.
Let’s go a step further and take the birds-eye view on Hershey stock since 1998 from an income perspective. If you start that period off with a block of 1,000 shares you’d have been looking at income of $500 in year one. Assuming you were reinvesting dividends along the way then by the time December 2009 rolls around (and you’re getting an itchy finger hovering over the sell button) that share count has grown to 1,263 and the per share dividend to $1.19. The annual income would’ve therefore grown to $1,503.50 if you decide to stop reinvesting at that point.
Say that provides you with the motivation to stick with the stock and not sell up. Okay, management freeze the dividend and the stock price hasn’t performed like you might want for a decade or so, but as far as the Hershey business is concerned the world is still spinning. Folks are still buying their Kisses, Kit Kats and Reese’s Peanut Butter Cups at stores up and down the US, with ten cents of every dollar of those purchases heading straight to the company’s bottom line.
Let’s say 2017 arrives and it’s the point you decide to enjoy the fruits of your investment. You’re not going to sell up, but you’re going to stop more dividend reinvestment. As of now you’d be looking at a share count of 1,490 and a dividend of $2.402 per share (for last year) pumping out annual income of around $3,579. In other words paying the long-game has given you 11.55% a year in deferred income growth since 1998.
This is why short-termism is a fool’s game with blue chip stocks. When last year’s takeover bid from Modelez International ultimately came to nothing there was a back and forth on Seeking Alpha with a commentator bemoaning the decision not to accept. His rationale was that the news sent the share price down and caused unnecessary losses for shareholders. This is a particularly poor way to view the situation for a couple of reasons, but one in particular stands out. It willfully ignores the years of compounding that lies ahead for Hershey shareholders. Would you rather take the instant gratification of a 15-20% rise, but lose out on a particularly great company for the long haul? Or would you rather hang on to it and check back in after a couple more decades of compounding? I’d take the latter every time.