Nearly two years ago, October 2008, Standard & Poor’s published results of a study that went back several decades and examined the impact that stock dividends had on total return (dividends +/- capital appreciation/depreciation) as well as stock price stability. Although not surprising, the results did illustrate the value of dividends as they pertain to total return and share price stability. As of this writing, with the ten-year U.S. Treasury Note hovering somewhere near 2½ % forcing investors to look for alternatives, we thought now would be a good time to examine the impact of dividends on total return. Some of these findings are detailed below:
“From August 1989 to September 2008, dividends contributed approximately 28% of the total equity return of the S&P BMI World Index, while price appreciation contributed roughly 72%.” However, “from August 199 to September 2008, dividend income accounted for as much as 52.05% of total return.” It is important to note that the timeframe referenced immediately above occurred during a period of time when the stock market was relatively flat.
The study notes further that “in addition to providing a steady source of income for investors, dividends also play another important role during periods of volatility. While price returns can be either positive or negative, dividend incomes are by definition positive. This provides a cushion during negative equity markets…. Not only are dividends positive, they are relatively stable through time. Wide swings in stock prices can be partly attributed to speculation and market sentiment; whereas dividend income, as a component of a company’s earnings, is less subject to speculation.” In fact a study done by Fuller and Goldstein (2004) “examined the return behavior of dividend paying and non-dividend paying firms in both up and down markets, from January 1970 to December 2000. The authors found that dividend-paying firms outperformed non-dividend paying firms more in down markets than they did in up markets. Therefore, dividends allow investors to capture the upside potential while providing downside protection in negative markets.”
What’s an investor to conclude from this information? We suggest that should your financial objectives allow for some allocation to the stock market, dividend paying stocks and dividend paying stock mutual funds represent an attractive alternative to fixed-income investments, including Certificates of Deposit and Money Market Accounts.
Investors looking for dividend income must first determine whether or not they can expect the dividends to continue at least at their current level. A relatively simple way would be to calculate the current annualized dividend as a percentage of total earnings from operations. For most companies, dividends should be no more than sixty percent of normalized earnings while for regulated utilities, this percentage can be as high as eighty. For even more security, calculate this percentage for the past five years. This will give you a clearer picture of the potential for a continuation of the dividends.
For accounts that can accept the risk of equity investing, we would consider Altria Group (MO); Conoco Phillips (COP); Darden Restaurants (DRI); Abbott Labs (ABT); the Jensen Fund (JENSX) and the Vanguard Wellington Fund (VWELX) which carry dividend yields of 6.1%, 4.1%, 3.1%, 3.5%, 1.04% and 3.02%, respectively.
THE BOTTOM LINE – With interest rates at multi-decade lows as a result of this “once in a lifetime bull market in bonds,” investors with a time horizon of more than five years might be wise to consider alternatives to Bonds, Certificates of Deposit, Annuities and Money Markets. Stocks with dividends can provide investors with more income than many bonds, but with some added risks.