On this episode of the Wiser Wealth Roundtable podcast, the team discusses dividend investment strategies and how those strategies have changed in recent years as growth stock returns continue to far exceed those of value stocks.
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Investing for Dividends
Dividend paying companies exhibit the ability to manage cash flow in such a way that they can meet an obligation to share profits with their shareholders. Historically, these firms have had a value tilt, however, that has begun to change, and the information technology sector is now the largest dividend paying sector in the S&P 500. Those companies that are traditionally thought of as growth companies are now paying the most dividends. Microsoft and Apple are some of the largest and most recognizable names that have joined this group of companies paying dividends. Others include Intel, Cisco and Oracle. The technology sector has passed other sectors like utilities and energy stocks that have traditionally been the most well-known for paying dividends.
Growers vs. Payers
Dividend growers are those firms that grow their dividends as their sales and profits grow. Dividend payers are those firms that using retained earnings to pay dividends. Growers and Payers are thought of and viewed differently in the market by investors.
The dividend yield of the S&P 500 is historically low at 1.5%, whereas the S&P High Yield Dividend Aristocrats is yielding around 2.75% but we are also at historically high prices right now. There is an inverse relationship between dividend yield and stock price. There are two types of returns for the major indexes we track: price return and total return. Price return is the difference between the current price of the stock and the price you paid for the stock. It can either be negative, zero or positive. Total return is price return + dividend return. Often, you will see a difference in price return and total return. It might go from negative to positive, just because you consider the dividend payment.
The S&P High Yield Dividend Aristocrats® index is designed to measure the performance of companies within the S&P Composite 1500® that have followed a managed-dividends policy of consistently increasing dividends every year for at least 20 years. The difference between the aggregate price return of the companies vs. the aggregate total return of the companies is 46% higher when you consider the compounding effect of reinvesting the dividends.
What does this mean? As stock prices fluctuate, dividend investors continue to collect dividend payments that increases their overall investment returns as they are reinvested. Price decline for dividend growers and payers has been less than companies that don’t pay a dividend or cut their dividend in downturns like the COVID-19 crisis we experienced last year.
Over the last 5-10 years, investors following a growth strategy have far outpaced a dividend investment strategy. From a portfolio modeling standpoint, why wouldn’t investors choose to take the higher growth strategy and shave off the gains for income? Because the dividend investor is looking for a stream of income that is consistent year after year. It is a different style of investing. Both are legitimate but on the growth example, you are still dependent upon those growth companies being valued higher each year. On the dividend investment side, those companies that increased their dividends in 2020 did so at a rate of about 8% which more than offset inflation of around 1.5%.
Making a decision around whether it will be a growth year or value year is difficult. At Wiser, we want to own both growth and value in our portfolios, although we currently have a slight tilt toward technology. It is very difficult to get income from fixed income investments these days. As interest rates have come down, you don’t see the same appreciation in bond prices like you do in equity prices. The dividend aristocrat strategy over the past 5 years has averaged over 11% annualized return.
However, it is also important to remember not to chase the highest yielding companies because those companies could be riskier. Those firms could be paying dividends out of retained earnings as a way to boost their stock price.
At Wiser Wealth, we build portfolios based on the client needs and risk tolerance. Our approach has always been focused on long-term investing.