Charles “Chuck” Carlson enthuses over a subject that should appeal to both income and total return investors: the big, safe dividend (BSD). He got hooked on the BSD in the summer of 1982, when he began working for Dow Theory Forecasts. At that time, he saw many attractive dividend-paying stocks yielding 6 percent or higher. Notwithstanding prevailing high (but falling) interest rates, he found stock dividends enticing because they enhanced overall return potential and, unlike bond coupons, grew over time.
In contrasting that period to the present, Carlson acknowledges that readers will find it hard to believe that the potential for profiting from stocks with BSDs persists. He points out that 15 percent of S&P 500 Index companies cut or omitted dividends in 2009—the highest percentage on record. With stocks falling sharply through the first quarter of that year, big, safe dividend payers, such as ExxonMobil and Altria Group, were standout performers. Carlson notes that over the long term (he does not specify the precise period), roughly 40 percent of a stock’s total return comes from dividends.
How does one find stocks with big, safe dividends? Yield is a good proxy for investment risk, according to Carlson, but not a dependable guide for stock selection. His basic formula considers just two data points: payout ratio and his proprietary Quadrix score. The Quadrix stock-rating system ranks more than 4,000 stocks, including American Depositary Receipts (ADRs), on more than 100 variables across six categories: momentum, quality, value, financial strength, earnings estimates, and relative stock price performance.
Carlson’s advanced BSD formula, which can also be used to evaluate real estate investment trusts and master limited partnerships, assesses dividend stability and growth on 10 factors. Carlson reports that this formula outperformed the S&P 1500 Index by more than 6 percentage points annually from 1994 to an unspecified end date (which seems to be 31 December 2008). He adds that the advanced BSD formula achieved those superior returns with less risk than the index, as measured by standard deviation. Most importantly, of the stocks selected by the advanced BSD formula at the beginning of 2008—one of the worst years ever in terms of dividend cuts—only two reduced their dividends during that year.
Carlson strongly recommends direct stock purchase plans and dividend reinvestment plans (DRIPs), which are offered by more than 1,000 companies. Investment minimums are small, and fees to purchase shares are modest. Also, many companies, including issuers of ADRs that trade on U.S. stock exchanges, allow investors to buy shares directly, which affords investors low transaction costs by truly going direct, thereby improving net total return potential. The “secret sauce” for building wealth is reinvesting the dividends rather than cashing them in. Investors who require current income can at least partially reinvest the dividends. Maintaining good records is imperative because, otherwise, tracking costs accurately to determine capital gains at tax time could be nightmarish.
Overall, The Little Book of Big Dividends provides excellent analysis, but one small item is problematic: The subtitle heralds “a safe formula for guaranteed returns.” Guaranteeing results is not an acceptable professional practice. To be fair, the only time “guaranteed” is mentioned in the book is on page 137, in connection with the strategy of buying stock at a discount via a DRIP, simultaneously selling the same stock at full market price, and pocketing the discount. The reliability of this strategy is somewhat subject to question, though, because of the market timing of the DRIP purchase and the manner of calculating the purchase price. In a DRIP program, the purchase price may be determined by multiday pricing periods or averages of high and low daily prices over a number of days. These complications necessitate impeccable record keeping and inhibit the execution of buys and sells in a truly open market.
The Little Book of Big Dividends should be an important component of a private wealth adviser’s discussion with clients about sources of long-term investment return and the critical importance of reinvestment in building wealth. Carlson addresses portfolio diversification and risk management in an accessible way. Readers will appreciate the manner in which he “names names” to paint a clear picture of how excess returns can be achieved through a simple and time-tested investment formula. He also underscores the need to supplement selection formulas with fundamental research in order to make optimal investment decisions.