The importance of dividend return is often ignored because price appreciation and capital gain remain the focus of many investors, especially during bull market rallies. However, the income generated through dividends remains an integral part of the investment equation. Dividends can contribute significantly to the stock market's total return over the long-term.
Dividends have played a significant role in the overall S&P 500 Index's total return picture. Dividends' contribution to the total return of the S&P 500 Index has varied over the past eight decades. During the 1940s, the dividend contribution to the total SPX return was 67%. In the 1950s it was 30%, the 1960s witnessed 44%, the 1970s (73%), the 1980s (28%), the 1990s (16%), the 2000s (negative total returns), and the 2010s (17%). From the 1930s to the present, S&P 500 dividends accounted for around 42% of the total return for the SPX index.
During the 1940s, 1960s, and 1970s dividends played an influential role, contributing more to the overall SPX total returns, when the SPX returns for the decade averaged less than 10%. On the other hand, dividends played a less influential role during the 1950s, 1980s, and 1990s, when the SPX annual total returns for the decade were double digits. Interestingly, during the prior bear market from 2000 to 2009, when the SPX produced negative returns, dividends provided a steady income stream, minimizing the losses.
Despite the recent sharp rise in interest rates, interest rates remain at historically low levels, and many investors continue to seek out income-type investments. However, investing solely in the highest dividend-yielding stocks may not necessarily be the most effective investment strategy, at least from a longer-term perspective. Why? Because some of these high dividend-paying securities are in prolonged structural downtrends. When prices decline for many years, the yield can rise for the wrong reason creating value traps.
The best way to determine whether a company can pay a consistent dividend and even grow its annual dividends is through the payout ratio. History has shown companies that raise their dividends over the long-term have experienced higher returns with less volatility as compared to companies that cut or eliminate their dividends.
Dividend growth investing has produced superior long-term returns because companies that can consistently grow their dividends have a stronger balance sheet, strong management, stellar business plan, and are more committed to their shareholders.
Investors have turned to dividend growth investing, favoring companies with a solid track record (blue-chip names) that can consistently increase dividends on an annual basis. After all, companies that can raise their dividend payouts year after year suggest that these stocks are growing their bottom lines and have steady cash flows to generate long-term capital gains.
In summary, dividend growth investing has proven to consistently outperform the stock market (SPX) and competing investment styles, producing higher risk-adjusted returns over the long-term. However, this year investors have favored S&P 500 High Dividend Yielding ETF such as SPYD (+19.73% year-to-date) and the S&P 500 Value (SPYV +9.80% YTD) over two popular Dividend Growth ETFs – Dividend Appreciation (VIG +1.56% YTD) and S&P Dividend Aristocrats (NOBL +6.08% YTD), and S&P 500 Growth (SPYG – 0.78% YTD).
Given the discrepancies in performances between the different investment styles, will there be a mean reversion later this year as investors return to the consistent and superior longer-term returns of dividend growth investing and growth investing? After all, an investment strategy that allows investors to grow their income, and at the same time, protect their purchasing power seems to be a reasonable and sensible strategy in an ever-increasingly volatile market environment.
Although there are numerous dividend and dividend growth investment vehicles, the following are some of the more popular and active ETFs: Vanguard Dividend Appreciation ETF (VIG), WisdomTree US Dividend Growth Fund (DGRW), and SPDR S&P Dividend ETF (SDY), and ProShares S&P 500 Dividend Aristocrats ETF (NOBL).
S&P 500 Dividend Aristocrats (NOBL) is interesting as this ETF tracks an equal-weighted index of S&P 500 constituents that have increased dividend payouts annually for at least 25-years. A company that can increase its dividend payout for 25 years or more implies that it is stable, profitable, growth-oriented, and well-managed. Isn't this the reason why we invest in stocks - for growth and income?
As of 12/31/20, the companies that offer the longest duration of increasing their dividends within the S&P 500 Dividend Aristocrats are MMM (58 consecutive years of rising dividends with a 10-year annualized return of 9.59%), KO (58 years/7.56% annualized return), CL (58 years/9.59%), DOV (58 years/11.58%), EMR (58 years/5.59%), GPC (58 years/9.35%), JNJ (58 years/11.76%), PG (58 years/9.89%), SWK (53 years/11.63%), and HRL (52 years/15.08%).