Great investors like Warren Buffett and Howard Marks have been trying to teach the world about the power of dividends (a type of investment income) for decades. Warren Buffett defines investment as the process of “buying productive assets”. What he means by “productive assets” is an investment that generates income. Income takes the form of a dividend paid in good old-fashioned cold, hard cash.
Buffett famously states that his favourite holding period for a productive investment, whether it is a whole company or part ownership via shares purchased on the open market, is “forever”. He certainly does not buy a business to sell it! He used this approach to build Berkshire Hathaway into a company with a market capitalisation of over $400 billion.
So, how can investment income wisdom be applied?
To adopt this income focused investment style, you need to buy companies that generate lots of cash to pay out to investors in the form of dividends. As long as the company grows, becomes more efficient or can charge increasing prices for its products, the dividends paid out to shareholders will increase every year.
Here is an example of an investment income calculation. The table below shows how McDonald’s dividends have grown at a rate of 17,9% per year. The dividend has been increased every year, even in the years where the share price declined. Reinvesting dividends would have grown your annual income by 20,8% as compounding accelerates.
If you had focused only on share price growth, you would have only gained 11,5% year over 20 years. You would have also suffered five declines over 20 years. However, with dividends in hand, these declines would have represented a golden opportunity to buy more shares in a great business at reduced prices.
| Year | Adj Close (End of Year) | Share Price Growth | Annual Dividends | Dividend Growth | Annual Dividend Payout |
|---|---|---|---|---|---|
| 1996 | 14.44 | 0.34% | 0.15 | 0.00% | 104.10 |
| 1997 | 15.30 | 5.94% | 0.16 | 6.67% | 112.32 |
| 1998 | 24.74 | 61.76% | 0.18 | 12.50% | 127.62 |
| 1999 | 26.09 | 5.44% | 0.20 | 11.11% | 142.80 |
| 2000 | 22.53 | -13.64% | 0.22 | 10.00% | 158.18 |
| 2001 | 17.69 | -21.51% | 0.23 | 4.55% | 167.21 |
| 2002 | 10.89 | -38.42% | 0.24 | 4.35% | 176.64 |
| 2003 | 17.07 | 56.77% | 0.40 | 66.67% | 300.80 |
| 2004 | 22.45 | 31.48% | 0.55 | 37.50% | 423.50 |
| 2005 | 24.09 | 7.30% | 0.67 | 21.82% | 528.63 |
| 2006 | 32.43 | 34.63% | 1.00 | 49.25% | 810.00 |
| 2007 | 44.23 | 36.38% | 1.50 | 50.00% | 1,252.50 |
| 2008 | 48.01 | 8.55% | 1.63 | 8.67% | 1,406.69 |
| 2009 | 49.93 | 4.01% | 2.05 | 25.77% | 1,830.65 |
| 2010 | 63.38 | 26.93% | 2.26 | 10.24% | 2,099.54 |
| 2011 | 85.34 | 34.66% | 2.53 | 11.95% | 2,433.86 |
| 2012 | 77.43 | -9.26% | 2.87 | 13.44% | 2,844.17 |
| 2013 | 87.97 | 13.61% | 3.12 | 8.71% | 3,204.24 |
| 2014 | 87.88 | -0.11% | 3.28 | 5.13% | 3,489.92 |
| 2015 | 114.61 | 30.42% | 3.44 | 4.88% | 3,794.32 |
| 11.5% | 17.9% | 20.8% |
So in 20 years, a $10,000 investment in McDonald’s would yield a dividend payout of $3794,32 in 2015. In total, you would have received $25,407.65 in dividend income without selling any shares; that’s 2,5 times your original investment without adding any more capital.
Cumulative Dividend Income (USD)
If you had followed the same formula for 30 years, the results would have been even more spectacular. By starting with the same investment $10,000 in 1986, your capital becomes your ANNUAL income in 2009 when you receive $11,966.13 as a dividend. In 2015 annual income would be $24,825.64, over 2,5 times your initial capital.
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