This opening quote from Mr. Rockefeller is a century and two decades old. Suffice to say how much things have changed ever since. Particularly, the one subject he is referring to: dividends. He might have been right at that time because companies used to pay out what can be seen today as a huge portion of their earnings. Nowadays, nevertheless, we could estate confidently that he is wrong.

Dividends or coupons are the favourite vehicles of many investors who believe they will have a safe stream of income for many years to come, especially those that have been told to allocate more money into “safe” stocks and bonds than to growth, young and riskier stocks. The truth is that in the case of bonds, coupons shrink in the long haul due to inflation. In the case of dividends, these aren’t often stable, the “safe” companies who pay them are, in fact, not safe, and the expectation of receiving them for years may shorten considerably.

If you have some savings and were thinking to easily increase your yearly income by investing in bonds, I have bad news for you: only those individuals considerably rich can maintain the lifestyle that the cash from coupons provides. Let’s illustrate with an example: Consider a retired couple whose $500,000 savings are invested in bonds paying 7% percent. This would provide a steady income of $35,000 annually. But with an inflation rate of 5%, the buying power will be cut nearly in half in ten years. And we would still need to pay taxes to the government What is sure is that bondholders will not see any company raise the rate on its coupons. The most they can expect is the principal back–after its value has been shrunk by inflation.

When we talk about dividends, the story is slightly different. Dividends can be raised, and they normally are, as long as the company keeps growing. Electric and telephone utilities, alongside energy stocks–Rockefeller’s niche at that time–are among the best dividend payers. As you can imagine, these are usually large well-established enterprises. And as such, they don’t have the potential to grow much more in the upcoming years. For this reason, they are called slow growers, and quite often, they quickly turn into no-growers. These are mature companies that grow at the pace of the economy (GDP), and cannot figure out ways to put that excess cash reserve and earnings into good use, so they give it back to shareholders. That is not a bad decision per se. In fact, it is better to distribute it than to squander it in new overpriced acquisitions that do not make sense–what Peter Lynch calls “diworsification”. Lack of strategic creativity alongside increasing ego lead many of these managers to believe that increasing in size is the best way to create value for the firm. Dividend payments, therefore, create discipline, leaving managers with no other option than to become efficient with the remaining cash and improve operations within the firm. This focus on core competencies–what Jim Collins calls the hedgehog concept–has most of the time proven to be not only a cheaper but a wiser decision.

Frequently, high dividend yields are what sustain the market price of those shares from falling further. This dividend yield, which is the ratio dividend-to-price, signals how much the company pays out in relation to its price. When the share price falls, the ratio becomes larger, and consequently, it lures new investors by the promise of a larger and more succulent check than before. This is especially attractive in times of crisis. This creates a “floor” where the stock eventually finds support. The lower the new price, the higher the dividend yield. But this seems to be something from the past. Recent academic research has exposed that typical value firms, those that frequently pay regular dividends, have been more adversely affected by the pandemic, causing the situation described above. If these stocks can’t be proved recession-proof and their growth capacity is seriously capped, what’s the purpose of owning them? Earnings growth is what truly enriches the value of a firm. Why waste time on firms that are going nowhere?

You should keep a very close eye on the business prospects and debt of the business. Highly indebted companies find themselves unable to keep paying such generous dividends in bad times, and alongside a hit in revenue generation, you may end up with a combination of a drastic dividend cut and a severe drop in stock price. Or in other words, with a bitter taste, sad tears… and an empty pocket. The impact on your portfolio would require years to recover, as roll over debt and restructuring isn’t something that happens overnight. As mentioned, these companies are neither small nor versatile. They are even criticised by some observers as unable to create actual economic growth for the country. That’s because they don’t provide revolutionary new products that make our lives easier. They are considered dinosaurs, many decades old, not precisely representative of the bright future ahead, but more of the past.

Despite the points mentioned, many investment managers still support this style of investment within their funds. If you are determined to trust your savings to them, you definitely must keep in mind these three points, and apply them to each stock of your portfolio:

–       The firm must have an economic moat. This is, for instance, well described in the book “Why Moats Matter”. The Morningstar approach makes sense, as only those companies that reveal a durable competitive advantage will be able to keep dividends safe and make room for higher dividend rates.

–       It must have as little debt as possible. A close inspection of debt ratios will reveal the capacity of the company to face short- and long-term obligations. The higher the debt, the bigger the dividend cut when it happens. This becomes especially important when the next economic downturn is around the corner. Remember that when the barber takes out the scissors, it’s rarely for a trim.

–       It must be a traditional dividend payer, during recessions and bad times included. Dividend payment history of some stocks goes back to the two world wars. If a company has been able to keep them for so long, it’s one of your safest bets.

The only essence of income investing is to invest in those assets that provide increasing cash flows in the future. That’s what you have to aim at. Stocks with low debt, promising prospects, that generate an increasing amount of revenues, and have a moat. In other words, companies with a “problem” of excess cash generation. I lean more on the side of Seth Klarman, who clearly stated: “stocks should simply not be bought on the basis of their dividend yield”. You can earn much more in capital gains–not taxed, just at the end–than by receiving taxed dividends. Let me reveal some valuable information that you may not know: small stocks have proven to overperform larger ones historically. They find new growth opportunities often, and they plow all their money into expansion. You can find all points mentioned above in such stocks, plus they are able to raise dividends with so much promising growth ahead. The overall idea is: don’t invest in stocks that are “too stable” or that have reached their full potential, don’t be bribed with dividends or drawn toward a high payout rate just because it looks easy and safe money. It is worth being invested in companies that still have room to grow. As per definition, they will keep generating new opportunities and, alongside, excess cash reserves. This will allow the company to raise the dividend rate. For both reasons, the stock will gain interest, attract investors, and push up the stock price. This, in technical terms, is called capital appreciation, and in combination with those dividends, will bring you happy tears.