Dividends are an essential part of investing. Most investors will have some dividend or income stocks in their portfolio and many companies see dividends as an important part of their shareholder relations strategy. Shareholders are the ultimate owners of publicly traded companies and being able to partake in the profits of a business in which you invest is a key benefit of owning a share.
Most investors view dividends as an income stream from their assets, the proceeds of which can boost income. And while there is nothing wrong with this strategy, it can blunt the performance effect dividend income has on your portfolio.
”‹Dividend Stocks: The Returns Cannot be Disputed
The benefits of owning high yield stocks and the compounding effect reinvesting dividend income can have on your investment returns are explored in Tweedy, Browne’s booklet "The High Dividend Yield Return Advantage: An Examination of Empirical Data Associating Investment in High Dividend Yield Securities with Attractive Returns Over Long Measurement Periods." This booklet is essential reading for any long-term investor, but if you have not got the time, I have picked out a few of my favorite studies from the booklet below.
The first study I want to highlight looks at the performance of high dividend stocks during bear markets. The study in question, titled "When The Bear Growls: Bear Market Returns 1970-1996," was first published in "Contrarian Investment Strategies: The Next Generation" by David Dreman (Trades, Portfolio). The study looks at the return of four value strategies (low price-to-earnings, low price-to-book value, low price-to-cash flow and high dividend yields) measured and averaged for all down quarters and then compared to the index itself for the 27-year period. All of the value strategies outperformed the market, but the price-to-dividend strategy produced the best returns. For the full 27-year period, through both up and down quarters, the price-to-dividend strategy produced an annualized return of 16.1% versus 14.9% for the market.
The second study I am picking is perhaps the most revealing. This study was first published in 2003, within the pages of the "Financial Analysts Journal." Entitled "Dividends and the Three Dwarfs," Robert D. Arnott, examined the various components of equity returns for the 200 years ending in 2002. This study is extremely revealing because its results are calculated over such an extended period. Two centuries is three or four times longer than the average investor is likely to be active in the market, so there is no way Robert Arnott can be accused of cherry picking results to support an existing conclusion. What is more, the extended period encompasses many different market conditions, including two world wars, the worst depression in recent history and the US Civil War. To put it another way, this study looks at the returns of a dividend strategy across all market environments possible.
So, what do the numbers show?
Between 1800 and 2002, the total annualized return of US equities is 7.9%. Of this, 5% comes from dividends, 1.4% from inflation, 0.6% from rising valuation levels and 0.8% from real growth in dividends. It is clear that over this period, dividends were the main contributor to returns.
Another study shows that over the 100-year period from 1900-2000, an equity portfolio in both the UK and the US, which included most importantly, reinvested dividends, would have produced nearly 85 times the wealth generated by the same portfolio relying solely on capital gains.
Conclusion
With this kind of evidence, it is hard to dispute the fact that dividends do not contribute significantly to long-term returns.
That said, in the current environment it is difficult to find dividend stocks that offer yields which are in excess of 5% per annum, but they are out there. By using the above information, you should be able to sniff out those dividend stocks that have both high and sustainable dividend yields. Your portfolio will thank you if you do.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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