Dividends Don't Lie

Instead of telling you what you already know, that dividends create tremendous value over the long run, I'll simply lay out the numbers, which are more powerful. The true value of dividends can be explained via a simple math problem. Consider the two scenarios:

In Scenario 1, you own $10,000 worth of ABC, which produces a 6% annualized return over five years. After five years, the $10,000 grows to about $13,400.

In Scenario 2, you own $10,000 worth of XYZ, which produces a 6% annualized return over five years. XYZ also yields 3%, which you then subsequently invest back in XYZ. XYZ also increases its dividend by an average of 10% a year. At the end of five years, your investment is worth close to $16,000.

If you run these returns over 15 years, under Scenario 1, your capital grows to $24,000, and under Scenario 2, it grows to nearly $40,000. My numbers may be slightly off because of rounding, but the value of dividends is made glaringly clear in this example.

Now let's add in today's real-world considerations: a zero-percent interest rate environment, inflation and what I would venture to guess will be a negative real rate of return in owning 10-year Treasuries that yield 1.8% today. Also, dividends are great when they can be counted on and don't come at the expense of a declining stock price. But there is also a secret about dividends that most of us know but few act upon: Dividends are real cash payments. You cannot manipulate cash flow like you can earnings per share.

The market seemed to figure out the dividend thing with Wal-Mart ( WMT) back in May, and since then, shares are up nearly 50%. Consider that for the preceding 10-plus years, Wal-Mart shares had been flat, except for the annual dividend. Wal-Mart now yields a decent 2%, but for some time it was sitting there paying out more than 3% a year until investors came charging in.

You may have missed out on Wal-Mart, but there are still some high yield dividends from quality blue-chip-like names that are set to offer respectable equity appreciation as well. The toy company Mattel ( MAT) currently yields 3.5%. The interesting thing about Mattel is that aside from the share-price volatility during the recession, shares just slowly grew over time. For the past decade, the company's average return on equity has exceeded 20%. Operating margins are in the high teens. Now for the best part: In 2002, the dividend payout was $0.05 a share; in 2011 Mattel was paying out $0.92 a share.

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