Dividend-focused strategies are most heavily used in outcome-based portfolios constructed for conservative investors seeking higher levels of income generation. But dividends are not just for income generation. They should not be viewed solely as a source of income, but also as a source of return. After all, the total return calculation has two components: price and income return.
For investors who have not yet considered dividends as a “return” driver within portfolios, here are three key reasons why the case for dividend investing extends beyond receiving a regular scheduled distribution, and why investors should include dividend strategies in more than just their income-based portfolios.
1. High and consistent contribution to total returns
Over the past 30 years, dividends from S&P 500® stocks have, on average, contributed exactly half of the index’s total return on an annual basis. While price returns of equities can fluctuate year over year, dividends tend to be more stable, consistently offering a positive contribution to total return each year. This is evident in the chart below, where dividends have comprised a significant portion of total cumulative return for time periods going back to 1970, both domestically and internationally. The recent negative price performance of international stocks drives home the importance of dividends in terms of total return, as it has been the only source of positive return for the MSCI World ex-US Index for the past five years.
Source: FactSet, as of 02/28/2019. All index returns used are total returns. Past performance is not a guarantee of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.
One of the strongest takeaways from the above is the compounding effect. As the time horizon is stretched out, that contribution to return becomes even more pronounced as dividends reinvested back into the stocks are able to continuously compound. To make this point even clearer, this section gets a second chart. The below chart shows the difference over the last 30 years between the return streams of the S&P 500 Price Return Index and the S&P 500 Total Return Index, which includes dividends.
Source: Bloomberg Finance L.P., as of 03/20/2019. All index returns used are total returns. Past performance is no guarantee of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.
2. Identifiable return premiums on dividend-paying stocks
If the dividend from the firms within those broad based indexes shown above has been the driver of returns, is there a rationale to then solely focus on firms that are high dividend payers in order to seek higher total returns?
Using the historical data from the Kenneth R. French Data Library, covering US-listed equities stretching back to 1949, research does show that investors do indeed earn a higher premium on dividend payers than non-payers.1 Shown below are the return streams of the firms that paid no dividends and those that ranked in the top 30%, middle 40%, and bottom 30% per their dividend yield (dividend-to-price). If we look at the cumulative performance going back over half a century, high dividend-paying stocks (top 30%) have significantly outperformed both the broad market, as defined by the Kenneth French MKT portfolio, and low or no dividend payers.
Source: Kenneth R. French Data Library, as of 01/31/2019. All portfolio returns used are total returns. Past performance is no guarantee of future results. Portfolio returns are unmanaged and do not reflect the deduction of any fees or expenses. Portfolio returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.
3. Strong historical performance during periods of volatility
Dividend stocks have historically weathered market volatility better than the broader equity market, as dividends may provide some cushion to capital losses. In the first section, we showed how the presence of dividends within broad exposures has benefited negative price performing international exposures over the last five years. In the analysis below, we isolate how this effect has been useful in short-term periods, too. As shown below, dividend focused strategies have produced higher quarterly returns than the S&P 500 Index over the last 18 years when the S&P 500 has fallen in a given quarter—and at a strong hit rate as well, with numerous periods of outperformance indicating consistency and persistence.
Source: Bloomberg Finance L.P., as of 12/31/2018. All index returns used are total returns. Past performance is no guarantee of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income.
It’s worth noting that the outperformance of the S&P High Yield Dividend Aristocrats Index—focused on long-term dividend growth—was even more consistent and significant than the MSCI USA High Dividend Yield Index, which focuses on high dividend payers. A potential reason for this is companies focused on increasing their dividends for a long period of time tend to exhibit higher quality characteristics. This means higher profitability, stronger balance sheets and less earnings variability—all traits that could lead to a smoother ride during market downturns.
Investors can seek both of these objectives—high dividend income and long-term growth of dividend income—with SPDR® ETFs. The SPDR Portfolio S&P 500 High Dividend ETF (SPYD) is a low cost ETF that seeks to provide a high level of dividend income and the opportunity for capital appreciation, while the SPDR S&P Dividend ETF (SDY) screens for companies that have consistently increased their dividend for at least 20 consecutive years, and weights the stocks by yield.
Both funds could help investors diversify the source of return in portfolios while offering the potential for reduced volatility during times of market turbulence, potentially realizing the benefits of dividend investing beyond just accumulating some income.
1Malcolm Baker and Jeffrey Wurgler, A Catering Theory of Dividends, The Journal of Finance, June 2004.
A distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property.
Kenneth R. French Data Library Dividend Portfolios
Portfolios are formed on dividend-to-price (D/P) at the end of each June using NYSE breakpoints. The dividend yield use to form portfolios in June of year t is the total dividends paid from July of t-1 to June of t per dollar of equity in June of t.
Kenneth French MKT Portfolio
A value-weight return of all firms incorporated in the US and listed on the NYSE, AMEX, or NASDAQ
MSCI USA High Dividend Yield Index
The MSCI USA High Dividend Yield Index is based on the MSCI USA Index, its parent index, and includes large and midcap stocks. The index is designed to reflect the performance of equities in the parent index (excluding REITs) with higher dividend income and quality characteristics than average dividend yields that are both sustainable and persistent. The index also applies quality screens and reviews 12-month past performance to omit stocks with potentially deteriorating fundamentals that could force them to cut or reduce dividends.
MSCI World ex US Index
The MSCI World Index is a free-float weighted equity index that includes stocks from developed world markets, and does not include emerging markets. It excludes US equities.
One of the six research-based smart beta factors that refers to “quality” equities. Quality companies are those whose stocks exhibit consistent profitability, stability of earnings, low financial leverage and other characteristics, such as ethical corporate governance, that are consistent with long-term reliability.
S&P 500 Index
A popular benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.
S&P High Yield Dividend Aristocrats® Index
The index is designed to measure the performance of companies within the S&P Composite 1500® that have followed a managed-dividends policy of consistently increasing dividends every year for at least 20 years.