We
believe that it pays to buy dividend-paying stocks. Dividends can
assist you in paying your bills, of course. Even better, dividends are
likely to improve your returns from your stock portfolio. This is
particularly true of ‘dividend aristocrats’. In Canada, that refers to
companies that have raised their dividends for at least five years in a
row.
As
their dividends climb year after year, dividend aristocrats yield more
and more—provided that their share prices stay the same. In fact, their
share prices usually rise. That’s because their rising dividends
attract income-seeking investors. These investors bid up their share
prices. If you own these dividend aristocrats, you win from rising
yields, a rising share price, or some combination of the two.
In
the U.S., the term ‘dividend aristocrats’ refers to companies that have
raised their dividends for at least 25 years in a row. If we applied
that criterion to Canada, this country would have very few dividend
aristocrats. Among our Key stocks, Fortis Inc. and Canadian Utilities
would qualify.
The U.S. criterion is too strict for Canada
The
U.S. criterion would also eliminate dividend aristocrats that have only
traded publicly for at least 25 years. This would, for instance, remove
Canadian National Railway from the list of dividend aristocrats, even
though the company has raised its dividend each year after going public
in 1995.
The
benefit of dividends is confirmed by many studies. Consider a study by
Professor Jeremy Siegel at the Wharton School of the University of
Pennsylvania. In his book Stocks for the Long Run, he writes, “The
historical analysis of the S&P 500 [Standard & Poor’s 500
stocks] Index, supports the case for using dividend yields to achieve
higher stock returns.
“On
December 31 of each year from 1957 onward, I sorted the firms in the
S&P 500 Index into five groups (or quintiles) ranked from the
highest to lowest dividend yields and then calculated the total returns
over the next calendar year.
“The
portfolios with higher dividend yields offered investors higher total
returns than the portfolios of stocks with lower dividend yields. If an
investor put $1,000 in an S&P 500 Index fund at the end of December
1957, she would have accumulated $201,760 by the end of 2012, for an
annual return of 10.13 percent. An identical investment in the 100
highest dividend yielders accumulated to over $678,000, with a return
of 12.58 per cent.”
The higher the yield, the better the return
A
dollar in the second quintile would’ve turned into $577 for a yearly
return of 12.25 per cent. The mid and bottom two quintiles lagged the
S&P 500 from December, 1957, through 2012. A dollar in the middle
quintile would’ve become only $144 for a yearly return of 9.46 per
cent. A dollar in the fourth-lowest quintile would’ve risen to $103,
for a yearly return of 8.79 per cent. The one anomaly was that the
bottom quintile slightly beat the fourth quintile. A dollar in the
fifth quintile would have turned into $109, for a yearly return of 8.9
per cent. Even so, higher dividend yields usually lead to better
returns.
Professor
Siegel also notes that “The highest dividend yielders also had a beta
below 1, indicating these stocks were more stable over market cycles.
The lowest-dividend yielding stocks not only had the lowest return but
also the highest beta [often used as a measure of risk]. The annual
return of the 100 highest dividend yielders in the S&P 500 Index
since the index was founded in 1957 was 3.42 percentage points per year
above what would have been predicted by the efficient market model
[better risk-adjusted returns], while the return of the 100 lowest
dividend yielders would have had a return that was 2.58 percentage
points per year lower.”
Go big or go home
Just
remember that the S&P 500 includes the 500 U.S. stocks with the top
‘market caps’. (The market cap is the number of shares outstanding
multiplied by the share price). These companies are generally more
stable than small firms. So they’re more likely to maintain their
dividends. Small firms may have no choice but to reduce or eliminate
their dividends.
Provided
that you’re buying big and solid companies, a higher-than-average
dividend yield is a positive indicator. With small companies, by
contrast, a higher-that-average dividend yield can indicate that
there’s a higher risk of a dividend cut or omission.
Please share this article
