At The Money: Profiting from Dividend Growth

Dividends are among the oldest and most highly regarded forms of equity investing. But in an era of mega-cap growth, should you own dividend-paying equities? David Bahnsen is founder, managing partner and chief investment office of The Bahnsen Group, a national private wealth management firm. His new book is “Profit from the profit: the past, present, and future of dividend growth investing.” Each week, “At the Money” discusses an important topic in money management. From portfolio construction to taxes and cutting down on fees, join Barry Ritholtz to learn the best ways to put your money to work. See omnystudio.com/listener https://omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Speaker 00

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• 2:14Barry Ritholtz?

  How often do you think about dividend investing, and in particular, dividend growth investing? Dividends are one of the oldest and most highly regarded forms of equity investing. But in an era of mega-cap growth, should you be chasing dividends or buying growth? David Bonson is the author of a new book, Profit from the Profit: The Past, Present, and Future of Dividend Growth Investing. He's also the founder and chief investment officer of the Bonson Group, managing over $10 billion. So David, let's start with just the title of the book, Profit from the Profit. Explain the difference between profiting from a company's underlying economic activity

• 2:59Barry Ritholtz?

  versus merely profiting from a change in stock price.

• 3:03Speaker 05

  Well, my view, Barry, is that all investing comes down, in some form or another, to the underlying profits of what is being invested in. And you could say, well, what about pre-profit companies, pre-revenue, venture capital? All of those things still are being invested in out of some outlook on future profitability. And to the extent you want something that's more liquid and a little more stable and diversify the types of things that usually are found in public markets, then you're dealing with underlying profits and some sort of discounting of those future profits into a present valuation. And what I'm suggesting here in the prepositional phrase, out of profit from the profit,

• 3:47Speaker 05

  is I'm saying, let's take those profits that we own the company for, and let's allow the individual investor to participate in those profits in the way that throughout history they often did, which is the receipt of a dividend. Now, of course, I recognize companies cannot pay all the profits out to their risk-taking investors. They need to hold on to some profits and retain some for a rainy day. They need to pay down debt. They need to reinvest in CapEx and growth of the company. But there has to be some reward to the risk taker, and dividends represent a palatable, tangible, repeatable profit from those profits.

• 4:27Barry Ritholtz?

  So let's dive into that philosophy, which you describe as really a philosophy of ownership rather than simply an investment strategy or even a tactic. I really like that framing. Explain the foundation of thinking of your ownership of a stock as owning a company.

• 4:48Speaker 05

  I believe it's an underlying business that has a market strategy, that has a management team, right? It's a real company. Every company we own is effectively a lemonade stand. And there's different levels of complexity and all of those things, and it's goods or services or both. But at the end of the day, it's a business. And one of the problems with the success of index investing is we do start to think something that isn't true, that we made our money from the market, from the index went up. Companies go up, and you can aggregate that, and the math gets very complicated. But there's only value being created when there are underlying businesses that are adding value,

• 5:33Speaker 05

  and that there are customers of businesses that are buying goods and services that meet the needs of humanity. So this underlying first principle drives what I believe about value creation and therefore the generation of profits, and from the generation of profits, the ability to reward shareholders with those.

• 5:50Barry Ritholtz?

  So some of the writings you've put out over the years that I've seen really draws a distinction between what you just described as value creation as opposed to buying a couple of numbers on a screen and the numbers go up. And you've been pretty blunt about describing there is a difference between owning a company and speculating in the market. Discuss that difference. How do you draw the line between economic investing and just speculation and gambling?

• 6:26Speaker 05

  Well, I think that by definition, the easiest line is things that are zero-sum versus things that are not. And so when you place a wager with your friend on the Mets game, first of all, if you took the Mets, you're probably going to lose the bet. Second of all, there's one winner, one loser. But when you invest in Procter-Gamble, I don't believe that's the case. You're investing in them creating new wealth, new profits, new opportunities, et cetera. And so that, by definition, de-speculates the investment to some degree. But also, there's just a lot of investing that is based on a guess of a price in a certain period of time. One of the reasons that we don't do option investing at my firm

• 7:09Speaker 05

  is because even if I have a lot of conviction in the company, and I can go buy a call option on it, but I can't make any money doing that unless I also attach the time value to it. But I'm not interested in speculating on when an announcement may come or when the company may be honored in the market with a higher valuation. Long-term value creation is not necessarily going to be within a timeline. And so, you know, there's different ways people can get to this. But our view is that the speculation, you know it when you see it. And at the end of the day, we're right now in a speculative mode. I never thought I'd see speculation like we saw in the 90s when I was starting my investing career

• 7:52Speaker 05

  and what we saw going into real estate with the pre-'08 period. There's been a lot of moments of speculative mania and fervor in my career. Right now, the instrumentation that exists for speculation with literal speculation in DraftKings and sports markets, and now these prediction markets, single-day option ETFs, all of this stuff, it's unbelievable. They're all consciously geared towards speculation. A dividend portfolio is saying, hey, I really believe people are going to buy soda pop or they're going to, you know, continue needing oil and gas to heat their homes, et cetera.

• 8:29Barry Ritholtz?

  Yeah, it's really becoming a problem, especially to the current generation of young men who pretty much have become gambling junkies, who was bad enough when people were betting on the outcome of games. But if you're betting on, is he going to hit this free throw? Well, you know, you're just throwing a dice. You might as well go to Vegas. Related to this, you've discussed in the book the difference between endogenous and exogenous returns. Dive into that a little bit and explain what those differences are and what it means to an investor, not a speculator.

• 9:06Speaker 05

  Well, essentially, we're just talking about the difference between trying to get your return from factors that are external, that are outside of your control, that are outside the underlying reality of the business. So in this particular case, we're sort of referring to what you believe others' psychology will be, how other investors are going to respond. I think the P/E ratio is going to get bid up because this stock is going to be popular. That would be an example of an exogenous factor, and I think it is by far the most, shall we say, prevalent way of thinking about investing.

• 9:50Speaker 05

  But when you're talking about stuff that is within the business, that my return is going to come from the performance of the company, from their success in growing profits and competing and creating value, then that's endogenous, and it is an entirely different mentality and approach. I do not suggest everyone's self-aware of this. I don't think it's total self-conscious. But I think that the implicit mentality or objective of many investors today is that they're betting on what others are going to do as opposed to betting on how a company is going to perform.

• 10:26Barry Ritholtz?

  Really, really, really interesting. So this book, Profit from the Profit, is a follow-up to your 2019 book, The Case for Dividend Growth. It's been seven years. I'm curious, what has changed either in the economy, the markets, or your own thinking that made an update of the book necessary?

• 10:48Speaker 05

  I think that you had basically the S and P nearly triple in seven years, which is crazy, by the way, crazy to think about. But we had had a bit of a dip in 2018, and so there's a little bit of convenient timing here. The S and P, I think, was down 5% in 2018 from the combo of a little bit of Fed tightening and Trump's, President Trump's trade war then. And then it rallied huge at the very beginning of 2019. We had a hiccup in COVID, but then really that only lasted about a month and ended up having a very robust period. There was one bad year. It's really the only bad year we've had since the financial crisis in 2022.

• 11:28Speaker 05

  But then Nvidia, three 100% years in a row, you just have had a massive rally. So it's worth saying, hey, David, was your thesis from seven years ago is to become antiquated? And you look at it and say, well, actually, Barry, I can't, I don't want to jinx myself for 2026, but when dividend growth was up 5% in 2022 and the S and P was down 18, and dividend growth did fine in the three years in between, not as much as the Nvidia stuff, but still did fine. And now a year like this year where dividend growth is beating the market by 400, 500 basis points, I think you're going to end up with a five-year number that's better

• 12:09Speaker 05

  than the market in a, but that's because of that first 2022 year. This story to me is very probable for the next three, five, seven years. At a 23x entry multiple on the S and P, earnings growth is great, but unless you think you're going to get a 29x, if you're going to actually have to fight against multiple contraction for the next few years, the math of the index return is what it is. I'm not being bullish or bearish here. I'm just being a mathematician. It's going to be very hard for the S and P to deliver continued 15% returns.

• 12:46Barry Ritholtz?

  Yeah, and the past few years, we've had 25% returns. Good luck keeping up with that.

• 12:51Speaker 05

  Exactly. And I think that the story of my first decade professionally managing money is what I'm now coming back to saying, look, the, the market can retreat here even with good underlying, you know, fundamentals. It's just that the Intels, Microsoft, Ciscos of the 2000s, all of them grew. Their earnings, their profits, their cash flows, all of them were lower at the end of the decade than the beginning of the decade. And I don't know that's going to happen with Nvidia. I'm not making a bearish AI call, but I am asking investors to realize that things are not as easy as they might have seen the last three or four years. And I think that the update of the book was a meant, was my attempt to restate, update

• 13:36Speaker 05

  the argument, new charts, new numbers. But then also, Barry, I think it's a little bit more philosophical. I'm adding a little more as to where I think about doomsday investing and dividend growth. And then I am encountering some of the objections. There's folks like Mel Faber that are notoriously talk about how a dividend is totally worthless, that all you're doing is taking from one part of the company, the balance sheet, giving it to someone else at zero sum. And I'm contending with that argument, contending with stock buybacks, contending with tax efficiency. Some may not find my arguments persuasive, but I am making an argument on all of those points.

• 14:14Barry Ritholtz?

  So typically dividend paying stocks are often concentrated in mature sectors, financial, energy, utilities, staples, things like that. How do you prevent dividend growth portfolio from being an unintended either sector bet or value factor bet?

• 14:32Speaker 05

  Well, the value factor bet is harder to avoid than the sector side. For us, it is true that we've always been very limited in our exposure to consumer discretionary because they, the consumer discretionary names by definition, it's hard to pay a sustainable dividend when you're depending on 16-year-old girls liking your clothes at the mall. It's just, it's a very discretionary sector.

• 14:55Barry Ritholtz?

  A little bit fickle, yeah.

• 14:56Speaker 05

  Exactly. But, but there's actually a lot of durability and, and all of the cool kids from the 90s are now dividend growers today. You know, your Qualcomm's and Ciscos and, and even Microsoft, it looks like a low yield because the stock price has gone up so much. But after George W. Bush's second tax cut changed the tax rate on dividends, Microsoft all of a sudden became a great dividend payer. So I suspect that a lot of these tech names, you know, could end up becoming good dividend growers, and some of them already are, Texas Instruments, Broadcom, but they're kind of old tech. They're not, they're not the cool tech stuff. But, but you, you want to keep benchmark agnosticism, in my opinion, but you still

• 15:40Speaker 05

  want to be sector diversified. So we own basically every sector to some degree or another, but my weightings to those sectors, I'm agnostic to what the benchmark is. We've been overweight energy and underweight consumer discretionary for most of my career. It's worked out just fine.

• 15:56Barry Ritholtz?

  Yeah, to say the very least. Let me throw an interesting curve ball at you. One of the most interesting companies that does not pay a dividend has been Berkshire Hathaway. They've created enormous value without ever paying a dividend. They occasionally, when, when the stock gets quote unquote cheap, they'll do some buybacks. And they're sitting on this massive, what is it, $300 billion cash pile? How do you distinguish between a company that should retain its earnings so it can make those opportunistic acquisitions versus one that really should be paying its shareholders some form of dividend?

• 16:37Speaker 05

  You know what's fascinating, Barry, is that Berkshire Hathaway is the company that proves my point, not the exception to the point. They are not a company. They are a holding company. And what do they hold? A whole bunch of companies that pay dividends to them. Now, they may choose not to return that cash to the shareholders because that's what the investors consciously bought was a holdco that you are asking Mr. Buffett and Munger in the years past, now a new management team to invest that capital. It's much more like a mutual fund of private and public companies. But the Coca Colas and Wells Fargos and Apples, and by the way, even the private businesses

• 17:20Speaker 05

  have made, the railroads and Seize Candies have made massive cash payments to the holdco. So it isn't really contradictory to it. There are companies out there that are operating companies that also have not been dividend growers, that have been very successful. But I would argue that I could find 100 examples of ones that didn't return capital to shareholders and set money on fire for every one I could find that proved to be a better steward of that capital. In the appendix of the book, I talk about the comparison of Viacom. And now that Sumner Redstone's no longer with us, I make him the foil because the amount of money these people set on fire over the years, they wouldn't pay a sustainable dividend.

• 18:04Speaker 05

  A lot of their competitors did, and then they just did these media M and A orgies, and all of them were capital destructive. That to me is much more common than a company that by not paying a dividend is creating more value.

• 18:19Barry Ritholtz?

  When we go to lunch, remind me to tell you the story of a company I was affiliated in that had an opportunity to do a special giant one-time dividend, and instead they lit the money on fire. But, but Berkshire, as, as the exception that proves the point, raises an interesting question. Do dividends and continually paid and actually increased dividends, does that impose, impose a discipline on, on management? And how could you distinguish when having to meet the dividend is a positive thing versus when it might discourage investment or innovation or intelligent risk-taking?

• 19:00Speaker 05

  You know, it's such a thoughtful question, and, and I'm not just saying this to blow smoke here, but I very much doubt that very many other interviewers are going to ask that to me because it's really an important question and you get it. Barry, that's a trade-off that, that exists, right? There is a sense in which a opportunity might get missed because the faithfulness to the dividend causes someone not to pursue a risk that might have ended up paying out. What I would suggest is that's a risk worth taking for most investors. Not those with a highly speculative or high risk, high beta, high octane part of their portfolio, but ultimately if someone had said, you know what, I'm not going to do this AOL Time Warner merger because we're not going to be able to sustain the dividend

• 19:42Speaker 05

  doing it, that would have protected about $300 billion of capital. And I could go on and on. Those are not nut picking examples. They're the norm. Now, there's been plenty of good and healthy M and A. Exxon's deal with Pioneer, Chevron's deal with Hess, Exxon's deal with Mobil, they didn't cut the dividend during COVID, for God's sake, when oil was negative. They didn't cut the dividend during Valdez, during the financial crisis. Having the social contract where your cash flow, your payout ratio, your balance sheet enabled you to sustain it, doesn't mean you can't do M and A, but it should mean you can't do reckless M and A.

• 20:22Speaker 05

  And I would suggest that Comcast has been a more faithful user of M and A than Viacom and Paramount were.

• 20:30Barry Ritholtz?

  I, I saved my favorite question for last, which is, you argue dividend growth allows investors to benefit from volatility rather than merely having to endure it. Explain what you mean by that. What's the philosophy behind benefiting from volatility?

• 20:50Speaker 05

  So when we say endure volatility, an S and P investor who is an accumulator, not a withdrawer, does not suffer from the volatility. And, and ultimately the premium return they get is a trade-off to the volatility that they're expected to deal with. And so that's all what it is. However, a dividend growth investor has an automatic purchase going on across a diversified portfolio. You assume volatility is a given, it's going to happen. So there is therefore no way to escape the fact that you are mathematically benefiting because you are already compounding, your return goes where it goes, and then you're getting more the next year, the next year.

• 21:32Speaker 05

  Now you're getting more purchases of the thing that is compounding. So it'd be, it creates an automated compounding machine within a compounding investment. And that leverage over time is monumental, and it ought to excite people that are 30, 40, 45 years old accumulating long-term because you can say to yourself, every time the market's down, I am buying more shares of the things that are in the future, going to be creating cash flow for me.

• 22:02Barry Ritholtz?

  And, and that's how you end up with the sort of stocks that are paying 30, 40, 50% of the original purchase price annually, which sounds crazy, but the math makes sense.

• 22:13Speaker 05

  Yes, sir. That's exactly right.

• 22:15Barry Ritholtz?

  So to wrap up, if you're interested in dividend growth investing, if you'd like to try and generate a market equaling portfolios with less volatility and a higher wealth creation, check out the new book, Profit From The Profit: The Past, Present, and Future Of Dividend Growth Investing by David Bonson. I'm Barry Ritholtz. You're listening to Bloomberg's At The Money.

• 22:56Speaker 06

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