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“Do you know the only thing that gives me pleasure? It's to see my dividends coming in.”
John D. Rockefeller, 1908.
In the current environment of ultra-low interest rates, investors are increasingly looking to equities for a source of income. However, high dividend strategies look attractive in today’s markets for a wide range of reasons.
When John D. Rockefeller, the world’s first billionaire and renowned philanthropist, remarked on his pleasure in receiving dividends from Standard Oil, he was inadvertently making the case for companies that pay high dividends. Not only do these stocks reward their investors with an attractive level of income, but their other qualities can translate into higher than average total returns.
Historically, higher dividend paying stocks have shown both higher returns and lower levels of risk (see figure 1 below).
S&P 500 portfolios, based on dividend yield
Source: VanEck analysis using data from Kenneth French. Data for the 50 years ending September 2019. Past performance is not a reliable indicator for future performance. This also holds for historical market data.
One reason given for high-dividend stocks’ superior risk-return characteristics is that a high level of dividend payout disciplines management. If a firm has too much free cash flow at its disposal, managers might be tempted to undertake value destroying projects, or spend on excessive salaries or perks. Another fact to consider is that, over the long term, dividends are the main driver of equity returns. In figure 2, we compare the performance of the US S&P 500 index including dividends and excluding dividends. It is clear that the former dwarfs the latter over time. Only a few companies have been able to generate above average long-term returns from share price increases alone.
S&P 500 return, including dividends and excluding dividends
Source: Bloomberg, VanEck analysis. Data for the period 2 January 1928 – 28 November 2019. Past performance is not a reliable indicator for future performance. This also holds for historical market data.
Dividends have also proved to be a good hedge against inflation. As can be seen in figure 3, dividend payouts have historically walked in lockstep with inflation levels. The explanation is intuitive: in periods of inflation, most companies can raise the prices of their goods or services, and as such, increase nominal earnings. This then translates into higher dividends.
10-year annualised inflation versus 10-year annualised dividend growth, USA
Source: VanEck analysis using data from Robert Shiller. Data for the period January 1871 – September 2019. Past performance is not a reliable indicator for future performance. This also holds for historical market data.
But beyond the long-term arguments, high dividend strategies seem particularly well suited for the current macro-economic environment.
A high dividend equity strategy can nowadays yield between 4% and 5% when investing in blue chip companies such as AT&T, HSBC, GlaxoSmithKline and IBM. In order to achieve such yields from Euro fixed income, one needs to make big sacrifices in both credit quality and duration.
Also, the fundamentals of high income strategies seem favorable. Currently, high dividend stocks are priced attractively, both in comparison to other stocks and to historical prices.
Price / earnings ratios
Source: Bloomberg, VanEck analysis. Past performance is not a reliable indicator for future performance. This also holds for historical market data.
Investors can find further comfort from current high levels of cash on companies’ balance sheets, which compare well with historical norms (figure 5). This gives companies sufficient capacity to sustain dividend payouts, even if their earnings fall. Yet despite the stockpiling of cash, current payout levels are below historical averages, giving leeway for further increase dividend payouts, see figure 6.
Total cash and cash equivalents for S&P 500 firms, USD trillion
Source: Bloomberg, VanEck analysis.
Dividend payout ratio for S&P 500
John D. Rockefeller may have extolled the virtues of high dividends over 110 years ago, but his sentiment has held true over the long term. Given today’s extraordinary economic environment of low or even below zero rates, the attraction of high dividends is stronger than ever.
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This commentary originates from VanEck Investments Ltd, a UCITS Management Company under Irish law regulated by the Central Bank of Ireland and VanEck Asset Management B.V., a UCITS Management Company under Dutch law regulated by the Netherlands Authority for the Financial Markets. It is intended only to provide general and preliminary information to investors and shall not be construed as investment, legal or tax advice. VanEck Investments Ltd, VanEck Asset Management B.V. and its associated and affiliated companies (together “VanEck”) assume no liability with regards to any investment, divestment or retention decision taken by the investor on the basis of this commentary. The views and opinions expressed are those of the author(s) but not necessarily those of VanEck. Opinions are current as of the commentary’s publication date and are subject to change with market conditions. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. All indices mentioned are measures of common market sectors and performance. It is not possible to invest directly in an index.
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