Collecting dividends was the cornerstone of my strategy that allowed me to reach financial freedom. Regular cash paid by the companies I own shares in gives me a steady cash flow. But can you spend these dividends and still accumulate wealth over time?
The simple answer is yes. This is because great companies that continually make good profits not only reward their shareholders with rising dividends (which is like a pay raise for investors), but also reward shareholders by either growing their business or buying back thier own shares.
As an example, lets take a look at a company that has a record of 38 consecutive years of dividend increases - CR Bard. This company manufacuters medical devices (a growing market with an aging population). It focuses its efforts on growth - even with it's envious dividend-payment history. For every $1 in profit it earns, it only spends 15 cents to pay dividends to investors. The balance is reinvested into growth. This approach has allowed Bard to increase profits at almost 15% per year over the last decade. This growth has allowed an investment in Bard to quadruple over the last decade while the US stock market in general, lost money for investors.
What about companies which don't have similar growth opportunities? They can use their extra profits to repurchase shares, which also creates wealth for investors over time. Let's take a quick look at how this would work. Suppose you own 1 share of "Big Money Company" and there are only 100 shares in total (to keep things simple). This would mean that you own 1% of the company. Now suppose the company buys back some of its shares every year and after many years there are only 50 shares in total (and you still own 1 share). In this situation, you have doubled your ownership in the company - from 1% to 2% - while spending the dividends. Let's look at a real-life example of how this would work.
Imperial Oil (Esso) is a large integrated oil company based in the Canada which operates in the oil and gas industry. This company only pays a dividend of 1% but then buys back a huge number of shares every year. The "true" cash returned to shareholders (when you factor in dividend payments and share repurchases) has been more than 5% in many years. These repurchases should continue as this is a very tax-efficient method for Imperial Oil to return money to it's parent company - ExxonMobil, but this same fact also benefits other shareholders. Over the last decade, more than one third of the company's shares have been repurchased. This has a similar effect to drips (dividend reinvestment plans - which I outlined in my second book, The Lazy Investor), but in a more tax-efficient manner.
My investment approach has favoured large companies which generate large profits. These profits are used to pay ever-increasing dividends with the remainder used to systematically grow the businesses and repurchase shares. Over time this approach has offered investors increasing income AND increasing wealth!
