The percentage of companies paying dividends to their investors has steadily fallen over the last few decades as management teams have increasingly opted to use share buyback mechanisms to return capital to shareholders.
Nonetheless, there are still many businesses that pay dividends, and income investing still has many adherents. A research note from investment firm Tweedy, Browne published back in 2007 explains why investing for dividends can be such a good strategy.
A powerful factor
Tweedy, Browne's basic thesis is that returns from dividend payments have historically comprised a very large proportion of the total returns from stocks, and that the data demonstrates that portfolios consisting of stocks with higher yields produce better returns compared to portfolios with lower dividend yields - over the long run.
The note cites evidence from the book "Triumph of the Optimists: 101 Years of Global Investment Returns," which found that between 1900 and 2000, a market-oriented portfolio with reinvested dividends would have produced 85 times the returns generated by the same portfolio's capital gains. It found that U.S. capital gains averaged 5.4% a year, while total return averaged 10.1% a year. The same was true in the UK - capital gains on their own accounted for a return of 5.1%, while total returns averaged 10.1% annually. Moreover, the authors also found evidence that returns from dividends accounted for the vast majority of returns over the last 200 years, eclipsing inflation, valuation expansion and earnings growth.
If you can, reinvest
An important caveat to all of this is that these studies assume reinvestment of all dividends. Of course, not all income investors choose to reinvest their payouts, and even those that do may not reinvest all of them - in fact, income from dividend stocks is often what sustains retirees and older investors who want to spend in their later years. In short, there are plenty of legitimate reasons to not reinvest. But for younger investors, the message should be clear - reinvesting dividends has historically provided an exceptional boost to portfolio returns.
Of course, just because something has been true in the past does not mean that it will continue to hold into the future. The historical data presented does cover a very long period of time, which lends it a lot of weight, but if the current trend of companies opting for buyback policies over dividend payouts continues, then the role of dividend investing will no doubt be diminished. Some of the best-performing stocks in the world do not pay dividends - Amazon (AMZN, Financial) and Facebook (FB, Financial) being just two examples. On the other hand, recent political calls to make buybacks illegal may cause the pendulum to swing in the opposite direction, prompting corporate boards to once again go back to the trusted dividend.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Bill Ackman Comments on Today's Market Environment
- Howard Marks: It's Hard to Find Good Risk/Return Today
- Aswath Damodaran: Are Markets Overvalued Right Now?
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