Warren Buffett’s mentor Benjamin Graham viewed a company’s dividend record as the primary factor upon which to base investment decisions. He saw a reliable steady dividend stream as an indicator of a company’s stability and profitability going forward. It’s difficult to argue with that view.
Unlike earnings which can be massaged and manipulated, dividends are real. A cash payment into your account or mailbox is a matter of public record. Yes a company can borrow money or dip into its cash reserves to pay dividends but even that situation is obvious when the dividend outweighs the reported earnings. So I feel more secure basing my investment decisions on the dividend stream instead of the “supposed” earnings stream.
In almost every case, a company that’s paying a dividend is a profitable company. A company that raises its dividend is saying they expect to remain profitable going forward. Stable, profitable companies is where I want to be invested.
Over the long term, stock price growth has been shown to closely track with dividend growth. While dividend stocks do tend to move up and down with the overall market, they also tend to be less volatile. Often they will retreat less than the overall market when there is a down turn or correction. In other words, dividends often provide a safety net for stock prices that earnings alone can’t. If earnings disappoint or vanish and there’s no supporting dividend, stock prices can plunge and take years to recover or possibly never come back. Dividends give investors a reason to stick with or revisit a company when yields rise to attractive levels.
Companies that pay dividends will usually attempt to maintain that dividend to avoid the damage to their stock that would result if they cut or omit the dividend. Therefore, dividend payments become self-perpetuating, and a dependable source of income as a result.
All in all, dividends provide multiple positive effects on a company’s stock. All that’s needed is the decision to take advantage of those effects.