Special to Cut The Crap Investing by Bob Ciura from Sure Dividend. Sure Dividend helps individual investors find high quality dividend growth stocks trading at fair or better prices.
Some investors tend to view dividend stocks as boring. Steady dividend payers do not get nearly the same level of coverage in the financial media as trendier, high-flying growth stocks. But the truth is that not only do the best dividend stocks offer investors reliable cash payouts, they have also outperformed stocks that don’t pay dividends over the past several decades.
Note: Dale recently covered why dividend investing works in his thorough review of the Tangerine Dividend Portfolio.
This outperformance goes against prevailing wisdom. In the years since the Great Recession ended, the uninterrupted bull market has enticed many investors to put their money to work in growth stocks, and to shun dividends for their perceived low returns. It might be tempting to overlook dividend stocks in a bull market, but perspective is warranted. Economic cycles contain expansion phases, and sooner or later, recessions. Economic downturns make the appeal of the best dividend stocks, such as the Dividend Aristocrats, even more obvious.
The great thing about dividend stocks is that they outperformed non-dividend stocks not just during recessions, but through all economic cycles. This means investors looking to buy shares of high-quality companies to earn strong returns over time, would be doing themselves a huge disservice by ignoring dividend stocks.
Why Dividend Stocks?
Dividends have a lot to do with the outperformance of the Dividend Aristocrats versus the S&P 500 Index. In fact, from 1926 through 2013, dividends represented nearly 43% of the returns generated by the S&P 500 Index. Capital gains through rising stock prices still represent the majority of returns, but to dismiss dividends entirely is a huge mistake.
The appeal of dividends is clear. Dividends represent a real return. Stock prices fluctuate every day, and just because an investor buys shares of a company he or she perceives as a well-run business with growth potential, does not necessarily guarantee the investor will generate positive returns. Other factors play a role in whether a stock price moves up after the investor purchases shares, such as valuation, or unforeseen events like geopolitical uprisings, wars, or changes in interest rates.
Dividends, however, are real cash payments to investors each quarter (or each month or year, depending on how frequently the company schedules its dividend payments). Investors can use the cash received from dividends for whatever purpose they wish. Investors can spend dividends to help pay for some of life’s daily expenses, or to buy more stock in the company. Reinvesting dividends is a great way to unleash the magical power of compounding interest, which allows the investor to earn even more dividends each year moving forward.
Dividends are especially valuable during times of low interest rates. For the past 10 years, the U.S. Federal Reserve maintained a policy of low interest rates, in an effort to help boost the economy in the aftermath of the Great Recession. While its policy of low interest rates helped stimulate economic growth, it also meant those with accumulated savings, such as retirees, were at a disadvantage. Rates on popular savings products like certificates of deposits (GICs in Canada) plummeted, as did bond yields. For those investors comfortable with buying stocks, much higher yields could be found among dividend stocks than what savers would earn from their local banks.
It is clear that dividend stocks offer investors a number of benefits. And while investing in dividend stocks is a great start, investors can do even better by focusing on dividend growth stocks. These are stocks that not only pay dividends to shareholders, but also raise their dividends over time.
Why Dividend Growth Stocks?
While dividend stocks are good, dividend growth stocks are even better. There is no shortage of verifiable research that proves dividend growth stocks have outperformed their non-dividend counterparts over time. Look no further than the Dividend Aristocrats, a list of 53 stocks in the S&P 500 Index that have raised their dividends each year for at least 25 years in a row. According to Standard & Poor’s, which compiles the list of Dividend Aristocrats as well as the S&P 500, the Dividend Aristocrats returned 13.3% per year over the last 10 years. Contrast these results with the S&P 500 Index, which returned 10.9% per year in the same period. That means the S&P 500 Dividend Aristocrats outperformed the broader index by 2.4% per year since 2008.
This completely upends the assumption many investors make, which is that dividend stocks naturally underperform during economic recoveries. The trailing 10-year period includes a virtually unimpeded bull market. And yet, the stodgy dividend growth stocks outperformed anyway. Even better, the Dividend Aristocrats combined their outperformance with lower volatility. In the past 10 years, the Dividend Aristocrats had a standard deviation—a widely-utilized measure of volatility—of 13.7%, compared with 14.8% for the S&P 500. The conclusion is undeniable. The Dividend Aristocrats not only outperformed the S&P 500 Index during the great bull market of the past 10 years, but they did it with less volatility as well. The difference is even more obvious looking back further. According to Ned Davis Research, had an investor put $100 into a basket of non-dividend paying stocks in 1972, that investor would have just $99 by 2013. Consider that this means investors actually lost 1% of their money over 40+ years. And, including the impact of recession, real returns would be even worse.
Now consider the returns generated by dividend stocks and dividend growth stocks. That same $100 invested in a collection of stocks that paid dividends but kept their dividends flat over time, would have amounted to $2,199 by 2013. That’s not a bad rate of return by any means, but consider that a $100 investment in stocks that initiated dividends or increased their dividends over time, would have been worth $5,997 by 2013. This seems shocking at first, but actually makes a great deal of sense.
Stocks that pay their dividends but don’t raise them, are typically in uncertain financial position. They are committed to returning a portion of their earnings to shareholders, but they cannot raise their dividends over time, presumably because their profitability isn’t rising. By contrast, dividend growth stocks such as the Dividend Aristocrats can afford to increase their dividends to shareholders each year, because their strong businesses are churning out rising profits over time.
The goal of all investors should be to increase wealth over time, by buying shares of high-quality companies. This can be accomplished in multiple ways, but when it comes to dividend stocks versus non-dividend stocks, there is no debate. Dividend stocks—and in particular dividend growth stocks—have outperformed stocks that don’t pay dividends going back over 40 years. As a result, investors looking to earn satisfactory returns over time while limiting volatility, should consider the best-in-class dividend growth stocks such as the Dividend Aristocrats.