The Third Way: Income from Stocks
Maybe I'm being a bit harsh with these examples. Fixed-income investments like bonds and certificates of deposit, as well as what you might call general stocks (those chosen without respect to dividends), may well have a part to play in your portfolio. Immediate annuities, investments where you turn over your funds to an insurance company in exchange for fixed monthly payments for life, could have a role as well. (You can't get your money back--as soon as you buy the annuity, the funds belong to the insurance company--but the yields tend to be quite a bit higher to compensate.) At any rate, the broader topic of asset allocation isn't the main focus of this book.
But what if there was a class of investments that could offer good current income that would grow as fast as or faster than inflation without any need for the investor to hold back part of this income for reinvestment? There is: stocks with large dividends.
To illustrate this phenomenon, I'll begin by drawing on an unconventional example.
Foremost among those who have made tons of money off Mr. Market over the years is Warren Buffett, a billionaire whose eminent wisdom and down-home charm have made him a household word. You might wonder how Buffett merits mention in a book about dividends, since his Berkshire Hathaway holding company has declared only one dividend on his watch--in 1966. (He has since suggested, perhaps only half jokingly, that he must have been in the bathroom when Berkshire's board voted to pay out that 10 cents a share.) The fact that Berkshire Hathaway hasn't paid a dividend in 40 years hasn't hurt the price of a Class A share, which has risen from $15 to more than $100,000, Buffett figures he can do a better job investing Berkshire's cash than shareholders can on their own, and just about anyone--even someone devoted to dividends like me--would have to grant him that.
Early in his investment careet, back when the assets at his disposal could be expressed in six or seven figures rather than eleven or twelve, Buffett focused his attention squarely on Mr. Market. Beginning in the 1970s, however, his emphasis started to change. He started buying entire companies--in essence, buying every single share of stock those companies had. The pennyante investors under Mr. Market's spell might be willing to sell their little bits of ownership at wildly undervalued prices, but knowledgeable businesspeople who control entire corporations are not. And once a company is off the public markets, there is no more Mr. Market to play games with. You won't find the value of See's Candies, Nebraska Furniture Mart, or Dairy Queen quoted in the papers or on the Internet. Because Buffett has bought these companies wholesale, these businesses do not even exist as far as Mr. Market is concerned.
If Buffett has given up the ability to trade these businesses on the stock exchanges, he must be obtaining an attractive return in some other way. That way, I have no doubt, is through dividends--large and growing ones, at that. Outside shareholders don't see these payments since they are conducted entirely underneath the larger Berkshire umbrella. But the earnings of Dairy Queen are not simply piling up inside that subsidiary's checking account; much, if not most, of the cash Dairy Queen and its Berkshire siblings generate is being returned to Berkshire. These returns aren't being delivered by Mr. Market; they come from the operations of the businesses themselves with only the lightest touch from Buffett himself.
Very few of us are in a position to acquire entire corporations and set dividend policies that suit our personal needs. Yet that does not mean that investors of ordinary means must simply take whatever Mr. Market dishes out, for good or for ill. To the extent that a corporation chooses to pay out part of its earnings as dividends, its shareholders find themselves in a position similar to the controlling owner of a business. The larger the dividends relative to the size of the investment, the more shareholders can control their own fate. Dividends allow the investor to harvest cash returns that are fully and completely independent of market prices. It isn't Mr. Market who pays dividends; only the underlying corporations can do that, and they can do it very well indeed.
