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The Case for Dividend Investing
In the current environment of historically low interest rates and yields, investors would do well to consider the benefits of dividend investing. Overtime, dividends have contributed a large proportion of the total return from equities, while the dividend component of the total return has also proved far less volatile. With the debate still raging over whether central bank actions around the world to stimulate global economic growth will ultimately prove inflationary, the potential for dividend growth as a ward against inflation should also be considered.
Global yields at their lowest level since 1790
The bull market in global bonds has seen the yield on US 10-year Treasuries decline from 15% in 1981 to as low as 1.4% in late July. As interest rates and yields have declined to the lowest on record, investors reliant on fixed income to meet their retirement or other needs have suffered.
With global economic growth remaining fairly tepid and with significant structural issues likely to continue to undermine growth, we expect yields to remain low for some time.
Whilst dividend investing makes sense to us in its own right, given the centrality to a value based investment strategy, we feel that now more than ever, dividend income from high quality equity has a role in portfolio construction.
Source: BofA Merrill Lynch Global Equity Strategy, Global Financial Data, Bloomberg
The contribution to return and compounding effect of reinvested dividends
The data we have on US equity returns show that the S&P Composite Index delivered a real return of 2.9% p.a. over the past 50 years (Dec-2011), with dividends adding 3.1% to bring the total return to to 6% p.a. Dividends therefore contributed more than half the average real return on a per annum basis.
These figures, however, understate the compounding effect of reinvesting the annual dividend yield, a quite significant sum over a 50 year period.
The chart below demonstrates the impact of compounding quite forcefully, showing how $100,000 invested in 1960 would have grown to US$1,353,464 by end-2011, with reinvested dividends contributing as much as 80% of the total return over this period.
Source: “Irrational Exuberance”, Princeton University Press, 2000, 2005, updated, Robert J. Shiller
Outperformance and lower risk
Dividends are of course also far more stable compared to price return. The standard deviation or volatility of the price return, suggests that in any given year, the return could be expected to differ by as much as 15% from the average of 2.9%. Dividends on the other hand, in addition to always offering a positive return, could be expected to differ by only 1.1%.
Individual dividend paying stocks also offer a superior risk – return profile, outperforming over the long-term and showing less downside risk during bear market phases.
Looking at the performance of the S&P 500 Dividend Aristocrats Index, an equally weighted index comprising companies with a record of 25 years or more of uninterrupted dividend growth and comparing the return to that of the S&P500 Index (equally weighted) itself, bears this out.
Since 1990 the Dividend Aristocrats have outperformed the index by more than 1% p.a. and 2.7% p.a. compared to the index on a market cap weighted basis.
|Total Return||Equally Weighted||Dividend Aristocrats|
Dividend growth and inflation
Finally, it is the ability companies have to grow their dividend, which sets dividend investing apart from other forms of income investing and which affords shareholders the ability to maintain real purchasing power.
Returning to the example above of dividend compounding, shows that the original US$100,000 invested in the S&P Composite Index in 1960 would have generated a yield of 3.2% in the first year.
With the market delivering growth in dividends of 5.4% p.a. the yield-on-original cost would have grown to 44% in the subsequent 49 years, highlighting the significant value creating potential of a growing dividend when compared to the cost of the original investment.
With inflation averaging 4% p.a. over this period, it is clear that the real growth in dividends of c1.4% p.a. would have ensured that the investor’s purchasing power would have been enhanced by this growth.
Dividend yield and growth in dividends, along with quality and value investment criteria, are at the centre of the investment process of our Select Equity and Progressive Yield portfolios.