Why Invest in Dividend Stocks?

There are two major reasons for owning dividend stocks;

  1. Better long-term returns
  2. Safety

One of the biggest myths in investing is capital appreciation accounts for the largest part of investors’ gains.  This concept is pushed on the investing public each day, as the nightly news flashes the most prominent stock market indices including the Dow Jones Industrial Average & S&P 500.  When the anchor broadcasts a large market drop, the price level of the index is solely discussed.  I accept that the large market indices give an investor a sense of how the market is performing in general terms, but it profoundly leaves out a key element of investor returns; dividends.   Dividends, or cash payments to shareholders, account for a substantial part of a stock investor’s total return. In fact since 1926, dividends have accounted for more than 40% of the total return of the S&P 500 stock index. In the last decade (2000-2009), the S&P 500’s total return of -9% would have been a heftier loss of -24% had it not been for the 15% contribution from dividends.

History has shown that dividends have been a powerful source of total return in a diversified investment portfolio, especially during periods of market turbulence. In examining the prior eight decades of stock market performance (table 1.1), dividends often account for more than 2/3 of the total return (1930s, 1940s, 1970s, & 2000s).  If an investor avoided dividend paying stocks during these elongated time periods, most of the total gains would be lost. Dividend investing is the key element to wealth building.

DIVIDEND CONTRIBUTION OF S&P RETURN BY DECADE

Years

S&P 500

Price %

Change

Dividend

Contribution*

Cumulative

Total

Return

Dividends

% of Total

Return

Average

Payout

Ratio**

1930s

-41.9%

56.0%

14.1%

>100%

90.1%

1940s

34.8%

100.3%

135.0%

74.3%

59.4%

1950s

256.7%

180.0%

436.7%

41.2%

54.6%

1960s

53.7%

54.2%

107.9%

50.2%

56.0%

1970s

17.2%

59.1%

76.4%

77.4%

45.5%

1980s

227.4%

143.1%

370.5%

38.6%

48.6%

1990s

315.7%

117.1%

432.8%

27.0%

47.6%

2000s

-24.1%

15.0%

-9.1%

>100%

35.3%

2010s

27.9%

8.4%

36.3%

23.1%

28.4%

Source: Strategas as of 12/31/12

 The Safety of Dividend Stocks

During those decades such as the 2000s where the stock market struggled to advance, dividends were a significant element for investor survival.  This is not only due to the dividends alone, but also the risk element of stocks that pay dividends.  Dividend stocks have historically provided lower overall volatility and stronger downside protection when markets decline. Since 1927, dividend stocks have consistently held up better than the broader market during downturns. You can measure downside risk through a statistic known as downside capture ratio.  Downside capture ratio is a statistical measure of overall performance in a down stock market. An investment category, or investment manager, who has a down-market ratio less than 100 has outperformed the index during a falling stock market.  For example, a down-market capture ratio of 80 indicates that the  portfolio measure declined only 80% as much as the index during the period. The downside capture ratio of high-dividend-yielding stocks, since 1927, has been 81% or lower over various long-term periods (table 1.2).  Put a better way, during months that the S&P 500 stock index fell, dividend stocks declined by nearly 19% less than the broader market.

DOWNSIDE CAPTURE RATIOS OF HIGH DIVIDEND STOCKS1927 TO 2011Table 1.2

                                                                 Downside Capture Ratio

Since 1927

81.53

50-year

67.45

30-year

65.86

20-year

65.83

10-year

81.61

Source: Kenneth French as of 12/31/11.

With the increase in overall market volatility over the last decade, dividends will continue to cushion downside risk and offer a reliable form of return.

 

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