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August 03, 2015 at 08:00 PM
It’s hard to argue with $376 billion. That’s the amount S&P 500 companies paid in dividends during the trailing-12-month period ending in January 2015, according to a recent FactSet “Dividend Quarterly” report.
It also was the fourth consecutive quarter in which the amount of dividends paid on a trailing-12-month basis reached a record high, FactSet notes. Over that period, dividends per share grew nearly 12%; six of the 10 S&P sectors reported double-digit increases, with 421 (84%) of S&P 500 companies paying a dividend.
Plus, payouts continued to move higher in the first half of 2015 (though at a slightly slower pace than previously), according to S&P Dow Jones Indices. This data set is broader than the S&P 500 and includes about 10,000 stocks traded in the United States. In addition, the group reported that dividend net increases (i.e., increases minus decreases) fell by roughly 10% to $49.5 billion for the 12 months ending June 2015 vs. an increase of $55.1 billion for the corresponding period in 2014.
However, for the year ending in June 2015, close to 3,100 companies increased their dividends, while only about 390 reduced them. It should be noted that dividend reductions were concentrated largely in energy stocks, as lower energy prices affected the cash flows of these companies.
The current dividend growth trend isn’t limited to American companies. Global dividends reached a record $1.17 trillion in 2014, 10.5% higher than in 2013 on a headline basis (the change in total gross dividends). That was the fastest increase since 2011, according to the “Henderson Global Dividend Study” (or HGDS), released in February 2015.
This underlying dividend growth, which the company calculates by stripping out special dividends, currency movements, changes in the index and changes in the timing of big dividend payments, grew by almost 9%. The HGDS index reached 159.9 at the end of 2014, meaning that dividends paid have grown almost 60% in just five years.
The Case for Dividends
Several factors support the case for investing in dividend-paying stocks. These include competitive yields.
“In this extremely low interest rate environment, it’s very hard to get yield,” said Ari Sass, portfolio manager of the MD Sass Equity Income Plus Fund of New York. “And if you’re going to get any reasonable amount of yield, you’re probably taking a significant amount of interest rate risk.
“I don’t know where interest rates are going, but I know at 2% (for the 10-year Treasury) the odds are that they’re going up over time, not down. So, I think in a quest for yield, one would have to go pretty far out in duration and would take fairly substantial interest rate risk,” Sass explained. “Dividend-paying stocks are an interesting alternative to bonds for those who want yield.”
In a spring 2015 research report, “The Compelling Case for Dividend Stocks in 2015 and Beyond,” Al Frank Asset Management (AFAM Capital) of Aliso Viejo, California, comes to a similar conclusion: “Considering that inflation has averaged 3% per annum over the past eight decades, those willing to accept the current yields on 10-, 20- and 30-year Treasuries are likely to see a reduction in purchasing power and little in the way of real return if they hold to maturity. And should they wish to cash out prior to 2025, 2035 and 2045, respectively, they risk capital losses.”
Seeking higher yields in developed markets overseas isn’t likely to pay off, either, the report adds, as rates in several of those markets have been even lower than their U.S. counterparts. Financial history also favors dividends, according to the AFAM Capital report.
Relative to Treasury bonds, the report notes, dividend yields “are about as attractive as they’ve been in more than 50 years. Aside from several months at the height of the ’08-’09 Global Financial Crisis, the last time the yield on the S&P 500 was as close as it is today to the yield on the 10-year Treasury was 1958.”
It’s important to seek stocks with growing dividends, not just currently high yields, because dividend stocks without payout growth are like bonds, Sass cautions. “We’re not interested in bond proxies,” he said. “We’re interested in dividend growers that would have much less interest rate risk than those that have dividends that are not growing.”
Contribution to Total Return
Dividend income alone isn’t a sufficient return for most investors, of course—the goal is to earn a total return comprised of dividends and capital appreciation. During bull markets, the contribution of dividends to total return is often modest. But from a long-term perspective, reinvested dividends contribute significantly to performance.
AFAM Capital’s research provides an illustration from the last 10 years. On Dec. 31, 2004, the Dow Jones Industrial Average was 10,800. By Dec. 31, 2014, the index had advanced to 17,800, an increase of 7,000 points, or 65% for the period. When reinvested dividends are included, however, the index increased by 114% on a total return basis.
Dividend stocks’ long-term relative performance holds up well, too. Using data compiled by professors Eugene Fama and Kenneth French, AFAM Capital calculated total returns for the period 1927-2014. “Dividend-paying stocks actually have delivered better long-term total return performance than non-dividend payers by a score of 10.4% per annum to 8.5% per annum from 1927-2014,” the group stated.
“Dividends are an important part of total return. Historically, they’ve been a much greater percentage of total return. If you look over the past, say, 70 years or so, dividends have been as high as 50 to 70% of that total return when you include their cumulative impact plus capital appreciation,” said Brian Campbell, a portfolio manager with the London Company and a sub-advisor of the Touchstone Large Cap Fund of Richmond, Virginia.
“Today, they’re much, much less than that. Now, dividends are roughly less than 20% of the total return in the last five years,” he added. “So, there’s a strong case to be made that they will be a bigger influence going forward.”
Dividends as Fiscal Discipline
Another important role for dividends is that they help hold corporate managers accountable for their financial decisions, says Campbell. The London Company’s investment selection process involves finding companies that allocate capital well, because capital allocation is the most important aspect of a manager team, he adds.
Sound capital management practices include returning capital to shareholders, either through buybacks, dividends or investing in projects that earn returns above the company’s cost of capital. “There are obviously advantages inherently involved with dividends,” he said.
“First, those income streams are a steady state and hopefully a growing state of income. That somewhat handicaps manager teams that are poor capital allocators from doing anything silly, you know, doing any destructive acquisition or overinvesting in a project that’s never going to earn a spread over the cost of that project. So, it does provide a little bit of discipline, and I think that’s helpful,” the portfolio manager explained.
“If you look at the S&P 500 today, more and more companies are paying dividends … 420 S&P 500 companies are now paying a dividend, and that’s up from 350, 15 years ago,” he noted. “So, the importance of dividends is being demanded by shareholders, and the discipline that it brings to manager teams is a positive for everyone involved.”
Lower Volatility
Investing in firms with capital-allocation discipline like dividend payers also can provide a cushion in down markets, Campbell notes. “We build our portfolios with a very conservative approach,” he said.
“They’re typically lower beta, higher quality and when markets do turn south, we’ve had the tendency to hold up much better than the index by and large. Now, as a byproduct of our process, we also have a higher average yield than the index, so our experience has indicated this that has actually helped when markets turn south,” the expert stated.
AFAM Capital’s research supports that contention. Using historical data sets, the firm calculated the volatility of long-term returns for dividend and non-dividend stocks. “Dividend-paying stocks have enjoyed lower volatility as the standard deviation measure from 1927-2014 equals 18.3%, compared to 30.1% for non-dividend payers,” according to its report.
