Capital gains for the dividend-oriented investor

Many beginning investors wonder why they would waste their time buying a stock that yields 2% - 4% when other companies offer much more. What they fail to understand is that the yield on the initial investment cost is much higher than the current yield. If the markets believe that the company's performance can improve over time, they buy and thus push up the price. This leads to capital gains, which further increases the wealth of the dividend investor who expects the price of a company that regularly increases its distributions to increase by a similar proportion. The returns would thus remain constant over the long term.

If investors don’t expect the company’s dividend growth to be sustainable, they’ll let the price stagnate or decline over a long period of time. Pfizer (PFE), for example, successfully raised its dividend when its stock price was stalling or flat. The company boasted a record 41 consecutive annual dividend increases. The pharmaceutical giant cut its dividend in 2009, ending that streak, when the yield was $10%. So investors have not only suffered from reduced dividend income, but also from capital losses over the past decade.

A similar situation occurred with General Electric (GE), which also had a long series of dividend increases, until it too cut its distributions in February 2009. The stock price The company's share price had a rough decade, falling from 60 to 6 before rising to 16. At the same time the company's current yield increased several times to more than 10%, until the company reduce its distributions more than 60%. 

Procter & Gamble (PG) in the 1970s tells us a completely different story. The company had already established itself as a solid payer of growing dividends, while the stock price appeared to be taking interest in the company's general improvement in finances.

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