But in today’s world of zero interest rates, dividend-paying stocks may be worth a closer look. Here are three reasons why:
Reason 1: Fixed Income? What Income?
Decent interest rates have been hard to find since the onset of the Great Recession, and just as the Federal Reserve (Fed) started normalizing rates, it cut them back to zero in response to COVID-19. As a consequence, bonds, once regarded as reliable sources of income, have struggled to pay investors any kind of meaningful yields of late.
That’s why investors in search of higher returns may want to consider some of today’s more reliable dividend-paying stocks. What’s more, some analysts believe a cyclical value “bounce-back” recovery may be just around the corner, spotlighting a handful of undervalued companies with balance sheets strong enough to survive the pandemic and cash reserves deep enough to allow for healthy shareholder dividends for years to come.
Reason 2: Consistency Has Historically Been Rewarded
Recent research shows that companies that offer steady sustainable dividends without going overboard on payouts have provided the best returns over time.
The study, by Wellington Management,2 divided dividend-paying companies into quintiles, then ranked them from highest to lowest level of payouts. The companies that outperformed the S&P 500 Index landed, surprisingly, in the second-highest rather than highest quintile. That’s right: the “high” beat the “highest.”
This counterintuitive result suggests that some companies were making “excessive” dividend payouts and leaving themselves with less money to invest in future growth, while companies with more moderate payouts were re-investing their earnings while still retaining enough flexibility to pay steady dividends for the long term.
Reason 3: Dividend Growth—A Sign of Good Management
In another recent study, Ned Davis Research3 looked at dividends from the vantage point of corporate behavior. The study asked: Since 1972, what kind of company had the highest returns and lowest volatility over time: Companies that grew their dividends? Companies that cut or eliminated them? Companies that stood pat? Or companies that didn’t pay anything at all?
The results showed that companies that grew or initiated a dividend experienced the highest returns relative to other stocks—with significantly less volatility.
The study also noted a strong correlation between corporations that consistently grow their dividends and those with strong fundamentals, solid business plans, and a deep commitment to their shareholders.
Bottom line: Although they’ve fallen somewhat out of vogue, dividends can still play an important role in providing income, especially in today’s low interest-rate environment.