When stocks have floundered directionlessly for a stretch, it usually doesn’t take long for investors to start pondering loading up on high-dividend payers. Then, the theory goes, they will at least earn something. We can see the theoretical allure. If stock prices are bouncing sideways, a large cash payout provides a near-term reward for sitting through the volatility. Yet in our view, this line of logic is too short-term and could lead investors into mistimed moves.
One curiosity about the dividends as solution to flat markets argument is that it commits a key error twice, in two different ways. Namely, it doesn’t consider stocks’ total return. Rather, it sets total return’s two components—price movement and dividends—against each other. To accurately consider whether high dividend paying stocks can offset flat returns, you must also look at high dividend payers’ price movements.
Full disclosure: In the very limited history of long bull market sideways streaks during the time when high dividend index daily total return data are available, high dividend payers beat the broad market. By limited history, we mean four data points excluding the present. Those are: 2/2/1994 – 2/14/1995, 2/11/2004 – 11/4/2004, 4/29/2011 – 2/24/2012 and 5/21/2015 – 7/11/2016. In all four, the S&P 500 Dividend Aristocrats beat the S&P 500 on a total return basis. Global high dividend data exist for the latter three. In each, the MSCI World Index High Dividend Payers beat the MSCI World Index.
Yet this information isn’t useful, because capitalizing on it requires perfectly timing these sideways stretches. Trouble is, by the time you realize you are in one, it is probably too late to do anything about it. You could technically date the present sideways stretch all the way back to January 26, 2018. In price terms, the S&P 500 is up just 3.4% since then (7.0% with dividends).[i] Knowing the past history of dividend payers during sideways stretches probably isn’t much help to an investor trying to decide what to do now. More meaningful, in our view, is what comes next.
High dividend payers’ record in the year following a sideways stretch is more mixed. Because the Dividend Aristocrats’ daily total return history begins during the 10/9/1989 – 5/29/1990 flat stretch, we have an extra data point for the year-after history. In the five occurrences, high dividend payers outperformed in two and trailed in three. Investing successfully is all about probabilities, not possibilities. In our view, a tactic that “works” less than half the time probably isn’t a great foundation for making a move.
Don’t get us wrong. We like dividends! We just don’t think investors should chase them for the sake of high payouts alone. Doing so risks putting on blinders to other factors like sector, size and style (e.g., value vs. growth), as well as the fact dividends aren’t etched in stone. Companies can—and do—cut them when the need arises. As for sector, many dividend payers concentrate in more defensive sectors that are likelier to underperform in an up market. We suspect that also explains their outperformance during the flat stretches.
Dividends are just one way companies return cash to shareholders—the other main way being stock buybacks. Neither is inherently superior to the other. Both give shareholders an, um, share in the profits, which investors can then use as they see fit. Dividend recipients can reinvest into the business, letting them compound over time. They can buy other stocks. They can use them for living expenses. Meanwhile, if a company uses buybacks, a shareholder can just do nothing, presuming the smaller supply of outstanding shares is a positive long-term driver. Or they can sell to the company, using the proceeds to invest in other companies or as spending money. Six of one, meet half a dozen of the other. Crucially, neither type of company demonstrates superior long-term returns. In the end, stocks are stocks.
Mostly, we think investors should just be mindful of the danger in reacting to the recent past. Watching a portfolio wind sideways for nearly two years is frustrating. Wanting to do something about it is an innate human response. But always ask yourself: Do I risk leaving returns on the table if I restructure my portfolio so that it would have done well over the past several months? Stocks look forward, not backward. In our view, investors are likely best off doing the same.
[i] Source: FactSet, as of 10/14/2019. S&P 500 Index price and total returns, 1/26/2018 – 10/11/2019.
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