In the 1990 film “crazy people,” an advertising executive decides to create a series of truthful ads. One of the funniest ads says, “Volvo—they’re boxy but they’re good.”
Dividend-paying stocks are like the Volvos of the investing world. They’re not fancy at first glance, but they have a lot going for them when you look deeper under the hood. In this insight, we’ll take a historical look at dividends and examine the future for dividend investors.
The Long-Term View
Dividends have played a significant role in the returns investors have received during the past 50 years. Going back to 1970, 84% of the total return of the S&P 500 Index1 can be attributed to reinvested dividends and the power of compounding, as illustrated in FIGURE 1.
The Power of Dividends and Compounding
Growth of $10,000 (1960–2020)
Data Sources: Morningstar and Hartford Funds, 2/21. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only. Dividend-paying stocks are not guaranteed to outperform non-dividend-paying stocks in a declining, flat, or rising market.
Decade By Decade: How Dividends Impacted Returns
Looking at average stock performance over a longer time frame provides a more granular perspective. From 1930–2020, dividend income’s contribution to the total return of the S&P 500 Index averaged 41%. Looking at S&P 500 Index performance on a decade-by-decade basis shows how dividends’ contribution varied greatly from decade to decade.
Dividends’ Contribution to Total Return Varies By Decade
Data Sources: Morningstar and Hartford Funds, 2/21. *Total return for the S&P 500 Index was negative for the 2000s. Dividends provided a 1.8% annualized return over the decade. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
Dividends played a large role in terms of their contribution to total returns during the 1940s, 1960s, and 1970s, decades in which total returns were lower than 10%. By contrast, dividends played a smaller role during the 1950s, 1980s, and 1990s when average annual total returns for the decade were well into double digits.
During the 1990s, dividends were de-emphasized. At the time, companies thought they were better able to deploy their capital by reinvesting it in their businesses rather than returning it to shareholders. Significant capital appreciation year in and year out caused investors to shift their attention away from dividends.
Dividends were de-emphasized in the 1990s, but after the dot-com bubble burst, investors once again turned their attention to dividends.
From 2000 to 2009, a period often referred to as the “lost decade,” the S&P 500 Index produced a negative return. Largely as a result of the bursting of the dot-com bubble in March 2000, stock investors once again turned to fundamentals such as P/E ratios2 and dividend yields.
FIGURE 3 summarizes the dividend yield for the S&P 500 Index from 1960–2020. According to Yale, the median dividend yield for the entire period was 2.92%, with yields peaking in the 1980s and bottoming in the 2000s. Today, investors continue to place a high premium on the more tangible and immediate returns that dividends provide.
The S&P 500 Index’s Yield Has Been Relatively Stable Over the Past Decade
S&P 500 Index Dividend Yield (1960–2020)
Data Sources: Yale and Hartford Funds, 2/21. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
When “High” Beat “Highest”
Investors seeking dividend-paying investments may make the mistake of simply choosing those that offer the highest yields possible. A study conducted by Wellington Management reveals the potential flaws in this thinking.
The study found that stocks offering the highest level of dividend payouts have not performed as well as those that pay high, but not the very highest, levels of dividends.
Stocks offering the highest level of dividend payouts have not performed as well as those that pay high, but not the very highest, levels of dividends.
This conclusion is counterintuitive: Why wouldn’t the highest-yielding stocks have the best historical total returns? Isn’t the ability to pay a generous dividend a sign of a healthy underlying business?
We’ll answer these questions in a moment, but we’ll begin by summarizing the methodology and findings of the study.
Wellington Management began by dividing dividend-paying stocks into quintiles by their level of dividend payouts. The first quintile (i.e., top 20%) consisted of the highest dividend payers, while the fifth quintile (i.e., bottom 20%) consisted of the lowest dividend payers.
FIGURE 4 summarizes the performance of the S&P 500 Index as a whole relative to each quintile over the past eight decades.
Second-Quintile Stocks Outperformed Most Often From 1930–2020
Percentage of Time Dividend Payers by Quintile Outperformed the S&P 500 Index (summary of data in FIGURE 5)
Data Sources: Wellington Management and Hartford Funds, 2/21. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment.
The second-quintile stocks outperformed the S&P 500 Index seven out of the 10 time periods (1930 to 2020), or 77.8% of the time, while first- and third-quintile stocks tied for second, beating the Index 66.7% of the time. Fourth- and fifth-quintile stocks lagged behind by a significant margin.
Compound Annual Growth Rate (%) for US Stocks by Dividend Yield Quintile by Decade
|Jan-1930 to Dec-1939
|Jan-1940 to Dec-1949
|Jan-1950 to Dec-1959
|Jan-1960 to Dec-1969
|Jan-1970 to Dec-1979
|Jan-1980 to Dec-1989
|Jan-1990 to Dec-1999
|Jan-2000 to Dec-2009||-0.44%||5.57%||4.15%
|Jan-2010 to Dec-2019||13.56%||12.98%||13.25%
|Jan-2020 to Dec-2020||18.40%||-4.90%||4.70%
Data Sources: Wellington Management and Hartford Funds, 2/21. US stocks are represented by the S&P 500 Index. Chart represents the compound annual growth rate (%) for US stocks by dividend yield quintile by decade from 1930-2019 and January 2020-December 2020. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
Payout Ratio: A Critical Metric
One reason why second-quintile dividend stocks came out ahead is because the first-quintile’s excessive dividend payouts haven’t always been sustainable. The best way to measure whether a company will be able to pay a consistent dividend is through the payout ratio.
The best way to measure whether a company will be able to pay a consistent dividend is through the payout ratio.
The payout ratio is calculated by dividing the yearly dividend per share by the earnings per share. A high payout ratio means that a company is using a significant percentage of its earnings to pay a dividend, which leaves them with less money to invest in future growth of the business.
The chart below illustrates the average dividend payout ratio since 1979 for the first two quintiles of dividend payers within the Russell 1000 Index.3 The first-quintile stocks had an average dividend payout ratio of 74%, while the second quintile had a 41% average payout ratio.
A payout ratio of 74% could be difficult to sustain if a company experiences a drop in earnings. Once this happens, a company could be forced to cut its dividend. A dividend cut is often viewed as a sign of weakness in the financial markets and frequently results in a decline in the price of the company’s stock.
Average Dividend Payout Ratio
Data Sources: Wellington Management and Hartford Funds, 2/21. Payout ratios illustrated are for stocks within the Russell 1000 Index. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
Do Dividend Policies Affect Stock Performance?
In an effort to learn more about the relative performance of companies according to their dividend policies, Ned Davis Research conducted a study in which they divided companies into two groups based on whether or not they paid a dividend during the previous 12 months. They named these two groups “dividend payers” and “dividend non-payers.”
The “dividend payers” were then divided further into three groups based on their dividend payout behavior during the previous 12 months. Companies that kept their dividends per share at the same level were classified as “no change.” Companies that raised their dividends were classified as “dividend growers and initiators.” Companies that lowered or eliminated their dividends were classified as “dividend cutters or eliminators.” Companies that were classified as either “dividend growers and initiators” or “dividend cutters and eliminators” remained in these same categories for the next 12 months, or until there was another dividend change.
For each of the five categories (dividend payers, dividend non-payers, dividend growers and initiators, dividend non-payers, and no change in dividend policy) a total-return geometric average was calculated; monthly rebalancing was also employed.
It’s important to point out that our discussion is based on historical information regarding different stocks’ dividend-payout rates. Such past performance can’t be used to predict which stocks may initiate, increase, decrease, continue, or discontinue dividend payouts in the future.
Based on the Ned Davis study, it’s clear that companies that cut their dividends suffered negative consequences. In FIGURE 7, dividend cutters and eliminators (e.g., companies that completely eliminated their dividends) were more volatile (as measured by beta4 and standard deviation5) and fared worse than companies that maintained their dividend policy.
Lowest Risk and Highest Returns for Dividend Growers & Initiators
In contrast to companies that cut or eliminated their dividends, companies that grew or initiated a dividend have experienced the highest returns relative to other stocks since 1973—with significantly less volatility. This helps explain why so many financial professionals are now discussing the benefits of incorporating dividend-paying stocks as the core of an equity portfolio with their clients.
Companies that grew or initiated a dividend have experienced the highest returns relative to other stocks since 1973—with significantly less volatility.
Average Annual Returns and Volatility by Dividend Policy
S&P 500 Index 1973-2020
|Dividend Growers & Initiators||13.20%||0.88||16.08%|
|No Change in Dividend Policy||10.97%||1.00||18.58%|
|Dividend Cutters & Eliminators||10.20%||1.18||24.47%|
|Equal-Weighted S&P 500 Index||12.57%||1.00||17.41%
Data Sources: Ned Davis Research and Hartford Funds, 2/21. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
Dividend Growth May Be a Key to Outperformance
Corporations that consistently grow their dividends have historically exhibited strong fundamentals, solid business plans, and a deep commitment to their shareholders.
The market environment is also supportive of dividends. A strong US economy has helped companies grow earnings and free cash flow, resulting in record levels of cash on corporate balance sheets (FIGURE 9). This excess cash should allow businesses with existing dividends to maintain, if not grow, their dividends. Interest rates are likely to stay historically low for some time, meaning dividend-paying stocks continue to offer attractive yields relative to many fixed-income asset classes.
Returns of S&P 500 Index Stocks by Dividend Policy: Growth of $100 (1973–2020)
Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
The Future for Dividend Investors
Trend 1: High Corporate Cash Could Bode Well for Dividends
In the aftermath of the financial crisis, corporations have been accruing record profits, and their balance sheets have swelled as a result. Cash on corporate balance sheets has more than doubled since the early 2000’s. Corporations can use this excess cash in a variety of ways, such as expanding their businesses or making acquisitions. While these options may be attractive in some environments, during uncertain times some corporations may be more cautious and choose to hold on to their cash in case of another economic downturn. Companies may also choose to use excess cash to initiate a dividend or increase their existing dividend payouts.
Record Levels of Cash on Corporate Balance Sheets
Data Sources: Federal Reserve and Hartford Funds, 2/21.
FIGURE 10 shows the confluence of two positive trends that could benefit dividend investors: high corporate profits for S&P 500 Index companies coupled with near record-low payout ratios. The average dividend payout ratio over the past 94 years has been 56.8%. As of December 31, 2020, the payout ratio stood at just 61.2%—leaving plenty of room for growth.
High corporate profits and near record-low payout ratios could benefit dividend investors.
S&P 500 Index Dividend Payout Ratio Quarterly Data (log scale)
Data Sources: Ned Davis Research and Hartford Funds, 2/21. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
Trend 2: Low Bond Yields Could Bode Well for Dividends
With bond yields still at relatively low levels, dividend-paying stocks may be appealing to many investors who are seeking yield. For example, retiring baby boomers who are searching for income-producing investments and institutional investors seeking yield may find dividend stocks more attractive than today’s low-yielding bonds.
Retiring baby boomers who are searching for income-producing investments and institutional investors seeking yield may find dividend stocks more attractive than today’s low-yielding bonds.
Yields for US Stocks Compare Favorably to Corporate Bonds
Data Sources: Bond Data - S&P High Grade Corporate Bond Index (1901-1968), Citigroup High Grade Corporate Bond Index (1969-1972, Barclays Capital Govt/Corp Bond Index (1973-1975), Barclays US Aggregate Bond Index (1976-2020); Stock Data - Cowles Commission All Stocks Index (1901-1925), S&P 500 Index (1926-2020); and Hartford Funds.
As of December 31, 2020, 69% of the stocks in the S&P 500 Index have dividend yields higher than the 10-Year US Treasury—that number being one of the highest on record. There have been seven calendar years that ended with more than 40% of S&P 500 Index stocks yielding more than bonds. Of those years, only one—1974—was prior to 2008 (see FIGURE 12).
Percentage of S&P 500 Stocks with Dividend Yields Greater than 10-Year Treasury Yields (1972–2020)
Circles represent year-end values, as of 1974, 2008, 2011, 2012, 2015, 2019, and 2020. Data Sources: Ned Davis Research and Hartford Funds, 2/21. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment. For illustrative purposes only.
Trend 3: Financial Repression and Institutional Investors
The US Federal Reserve (Fed) held interest rates low in the aftermath of the Great Recession. They attempted to normalize rates from 2015-2018, then cut them again in 2019 and 2020. The Fed has stated their intention to keep rates low at least until 2022.
We generally think of monetary policy as a catalyst to help accelerate or decelerate economic activity, but it can also be used for other purposes. By keeping interest rates low, the Fed helps keep interest payments on the national debt low. In other words, low interest rates benefit not only businesses and consumers who want to borrow money, but also the biggest debtor in the world: the US government.
Low interest rates make it easier for the US government to make payments on outstanding debt, and these lower debt payments make severe austerity measures less necessary in the short term.
Low interest rates benefit debtors and punish savers. Investors who have money in CDs,6 money market funds,7 and savings accounts8 are receiving startlingly low rates. Meanwhile, low interest rates make it easier for the US government to make payments on outstanding debt. These lower debt payments make severe austerity measures less necessary in the short term. But the burgeoning level of US government debt could one day lead to severe austerity measures.
Low interest rates are especially problematic for institutional investors. How long can a pension plan with an actuarial discount rate of 6% or higher continue to accept 10-Year US Treasury Bonds9 that yield around 1.5%?
Institutional investors who have identified the trend toward financial repression have numerous options, including high-yield bonds,10 bank loans,11 sovereign debt of foreign countries,12 REITs,13 and dividend-paying stocks.14
In fact, since 2008, institutional investors have poured nearly $84 billion into equity-income funds while individual investors have withdrawn nearly $103 billion from them over the same time period (see FIGURE 13). It’s not uncommon for institutional investors to be ahead of the general public when it comes to investing, but how long will this striking disparity last?
Institutional Investors Have Gravitated to Equity-Income Mutual Funds While Individual Investors Have Fled Them
Cumulative Net Asset Flows (2008–2020)
Sources: Morningstar and Hartford Funds, 2/21. Flows into the equity income category can vary significantly from year to year as different funds move in and out of the category.
Dividends have historically played a significant role in total return, particularly when average annual equity returns have been lower than 10% during a decade.
Stocks in the highest quintile of dividend yields have historically underperformed stocks in the second quintile. Therefore, investors should only use yield as one consideration when selecting a dividend-paying investment.
Furthermore, dividend growers and initiators have historically provided greater total return with less volatility relative to companies that either maintained or cut their dividends.
Trends that bode well for dividend-paying stocks include historically high levels of corporate cash, historically low bond yields, and baby boomers’ demand for income that will last throughout retirement.
Today’s interest rates are leading to financial repression as a way for the US government to help reduce the deficit without severe austerity measures. This has led institutional investors to invest heavily in dividend-paying stocks and strategies, which has helped bolster their performance. This trend shows no sign of abating as long as interest rates continue to remain relatively low, and demand for these investments will only grow if retail investors follow the lead of institutional investors.
Talk to your financial professional about the benefits of incorporating dividend-paying stocks into your portfolio.
1 S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks. Indices are unmanaged and not available for direct investment.
2 Price/earnings “P/E” ratio is the ratio of a stock’s price to its earnings per share.
3 The Russell 1000 Index measures the performance of the large-cap segment of the US equity universe. It is a subset of the Russell 3000 Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership.
4 Beta is a measure of risk that indicates the price sensitivity of a security or a portfolio relative to a specified market index.
5 Standard deviation measures the spread of the data from the mean value.
6 A CD (certificate of deposit) is a savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are insured up to $250,000 per depositor by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Association (NCUA).
7 Money market funds are not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although the funds seek to preserve the value of the investment at $1.00 per share, it is possible to lose money by investing in the funds.
8 A savings account is an account provided by a bank for individuals to save money and earn interest on the cash held in the account. Savings accounts are typically insured by the Federal Deposit Insurance Corporation (FDIC).
9 US Treasury Bonds are backed by the US government and are guaranteed as to the timely payment of principal and interest. This guarantee does not apply to the value of fund shares.
10 High-yield securities, or “junk bonds,” are rated below-investment-grade because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities.
11 Bank loans are below-investment-grade, senior secured, short-term loans made by banks to corporations. They are rated below-investment-grade because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities.
12 A government bond is a bond issued by a national government denominated in the country’s own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Timely payment of interest and principal payments on sovereign debt is dependent upon the issuing nation’s future economic health and taxing power.
13 A REIT, which stands for Real Estate Investment Trust, is a company that owns or manages income-producing real estate. REITs are dependent upon the financial condition of the underlying real estate. Risks associated with REITs include credit risk, liquidity risk, and interest-rate risk.
14 A stock is an instrument that signifies an ownership position (called equity) in a corporation, and represents a claim on its proportional share in the corporation’s assets and profits. Dividends are a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. There are no guarantees connected with the dividend payouts for dividend-paying stocks.
Important Risks: Investing involves risk, including the possible loss of principal. • There is no guarantee a fund will achieve its stated objective. Security prices fluctuate in value depending on general market and economic conditions and the prospects of individual companies. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • For dividend-paying stocks, dividends are not guaranteed and may decrease without notice. • Foreign investments may be more volatile and less liquid than US investments and are subject to the risk of currency fluctuations and adverse political and economic developments. • Different investment styles may go in and out of favor, which may cause a fund to underperform the broader stock market.
This information should not be considered investment advice or a recommendation to buy/sell any security. In addition, it does not take into account the specific investment objectives, tax and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice.