My F&M

Dividends Matter

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Our domestic stock selection strategy has always favored dividend-paying companies and especially those that are growing their dividends.  This is grounded in the knowledge that dividend income has historically constituted around 40% of the total return from stock investing.  It also reflects the conviction that dividend growth is an important indicator of a growing business and management’s confidence in the continued growth of that business. 

The benefits of this approach have been confirmed in a recent study by Ned Davis Research that examined the returns of stocks in the S&P 500 over 15-year rolling periods starting in 1972 and ending in 2014.  The study compared groups of stocks segregated monthly into one of four groups: non-dividend payers; dividend cutters or eliminators; dividend payers with flat dividends; and dividend growers or initiators.  Over every one of the 324 separate periods of 15 years in the study, dividend growers or initiators were the best performing group, and dividend payers with flat dividends were second best.  The dividend cutters and non-dividend payers were the weakest performers over every 15-year period!  Furthermore, these last two groups not only underperformed the first two groups, but they were far riskier (more volatile) while doing so.

While it is reassuring that a dividend-paying stock strategy pays off in the long run with more return and less risk, there are shorter periods of time when it does not.  The times when the dividend strategy does not work as well tend to occur when investors’ appetite for risk is high.

As you can see in the graph (below), the late 1990’s tech boom was such a period as non-dividend payers sharply outperformed dividend payers. You can also see that this surge by the non-dividend payers ended very badly a few years later. 

The second graph (below) shows that a less extreme version of this pattern of temporary underperformance of dividend payers has occurred over the last two years.  

The recent performance of domestic stocks in your portfolio has reflected this divergence from the long-term reward of investing in dividend payers.  We do not know how long this anomaly will last, but we do have confidence that sticking to our discipline of favoring companies with growing dividends will continue to pay off for our clients in the long run.