Friday, October 25, 2013

Moats Matter for Dividend Investors

"Why Moats Matter for Equity Income" Josh Peters, Morningstar

"The first thing you have to remember about dividend investing is that dividends are paid out slowly, though, relentlessly, and they really add up over time. But if you're going to actually buy a stock for its dividend, then this is going to be probably a five-, 10-, or 20-year-type of relationship. That means you have to think about their earnings potential and growth potential of the company, five, 10, 20 years, or longer into the future.

Now most of Wall Street focuses on those short-term news events. What will [the companies] make this quarter? Will they beat estimates? Will they raise forecasts? But again, if you're hanging around for the dividend over the long run, then you have to think about the long-run earnings power, and that is almost entirely going to be shaped by the company's competitive position in its industry. What's the industry structure like? Can the company actually preserve a good level of profitability and be able to grow in its field over the long term without competitors coming in and slashing away prices and ruining the game for everybody.

So, to have an economic moat and to be able to identify what it is that protects this business and its profits and its future growth potential from competition, is absolutely essential. It may not seem like it has a lot to do directly with dividends, but it really does."

Josh Peters nails the intersection of quality and dividends. I wrote about a similar concept - One Reason Why Dividend Investing Works So Well - who cares about a 3% yield? Its chump change on a short term on a basis, but not a long term basis its anything but. You want to see the dividend grow over time. If you want your 3% yield to grow to 10% yield on cost, even if it grows by 10%+ per year, you are still going to be holding the stock for a decade to get there. And longer to realize the long run benefits. So you're automatically re-oriented to businesses with staying power. Criteria should focus on identifying marathon runners not sprinters.


2 comments:

  1. This is exactly what so many people fail to see. I actually misunderstood dividends at the beginning too. I thought 3% dividend is for suckers and by trading I could get better than that. Well, the right opposite was the truth. I lost a lot of money trading before I learned that the growth is what makes dividends so powerful. For example JNJ stock. I hold the stock relatively short time, only for three years so far and yet my YOC is already 5% while the current yield is 2.87% and capital appreciation + dividends make this stock making me 107% gain already!

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  2. @Martin - yes I missed it at first too. YOC is likewise misunderstood, in my view its subtle but important - not useful for comparing to current yield, but very useful as "North Star" to navigate towards when making new purchases

    http://totalreturninvestor.blogspot.com/2013/09/the-wine-cellar-remarkable-true-story.html

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