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How Dividend Investors Can Protect Their Principal

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One of the interesting things about owning a high-quality asset such as an obviously excellent business is that it only takes a few years of dividends and general profit growth to protect the principal amount of your investment.

Take something like Johnson & Johnson, for example.

In 2010, Johnson & Johnson earned $4.76 in profit, and paid out $2.11 in total dividends. The absolute highest price that Johnson & Johnson traded at in 2010 was $66.20 per share. That works out to a P/E ratio of roughly 14x earnings.

But look what has happened in the three years since: you collected $2.11 in dividends in 2010, $2.25 in total dividends in 2011, $2.40 in total dividends in 2012, and $2.59 in total dividends in 2013. That means each share has collected $9.35 in total dividends over the past three years.

If you had purchased some Johnson & Johnson stock at the absolute highest price point in 2010, here is what would have to happen for you to experience a loss of principal: first, we’d have to subtract the $9.35 in total dividends that you would have collected. That brings us down from $66.20 per share to $56.85 per share.

Then, we have to adjust for the fact that Johnson & Johnson is now pumping out $5.48 in total profits. For Johnson & Johnson to trade below $56.85 per share, the company would have trade at 10.3x earnings.

During the absolute low point of the crisis in early 2009, Johnson & Johnson traded at a valuation of slightly over 10x earnings. In a way, it only took a person that bought the stock in 2010—at the absolutely highest price point—three years to reach a position in which the worst financial crisis of our lifetimes could repeat itself and we’d still break even on the stock holding.

When own a company that keeps growing its profits each year, and you combine that with the total dividend in aggregate that you receive over the course of three to four years, it does not take much to protect your overall principal from loss.

When you watch CNBC, they just show you a stock chart of a company at the high price of 2007 and then compare it to the absolutely lowest point that the stock reached in 2008 and 2009 to try and indicate the presence of extreme volatility. And some people fall for that and swear off the stock market, convincing themselves that it is rigged.

But you don’t have to make it that damn hard. There are countless companies out there that increase profits at a very minimum, seven out of every ten years. Coca-Cola. Colgate-Palmolive. Johnson & Johnson. Procter & Gamble. You know which companies they are.

After just a couple years of dividend payments, and when you adjust for the company’s new earnings power base going forward, you will find yourself in a position where it is exceedingly unlikely you will take a loss.

Some people say they don’t invest in stocks because they can’t stand the volatility in the stock prices. That’s only true if your thinking is exceedingly short term. If you only buy ownership stakes in companies that you fully understand and that generally grow their profits every year, you will find yourself protecting your principal. Since 2007, Procter & Gamble has paid out $12.57 in total dividends. Even when Procter & Gamble was overvalued in 2007 before the financial crisis hit, the price hit a high of $75.20. When you subtract the $12.57 in dividends paid out, the stock would have to fall below $62.63 for you to be in the red today. And that is assuming you overpaid for the stock right before the worst economic crisis since the late 1920s and early 1930s. If you want to protect your principal, you just have to find a company that keeps growing its profits, and hold on to the damn thing for a few years, and then you’ll be fine.


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