Recently, the Wall Street Journal reported the results of research published by the highly respected Ned Davis organization. According the article, data from Ned Davis Research showed that, since 1972, stocks in the S&P 500 Index that had consistently increased their dividends generated average total returns that were 2.2 percent greater (on an annualized basis) than stocks that didn’t raise their dividends.
The article noted that during the 36-year period, $100 invested in dividend-growing stocks would have increased to $3,547, while the same starting amount invested in stocks with stable dividends would have grown to only $1,745. That 2.2 percent annual difference resulted in one’s dividend growth portfolio value now being about double a portfolio of stocks that paid but didn’t increase dividends.
The Journal missed the story. While there’s a meaningful difference between the performance of stocks that raise dividends versus those that don’t, the difference in returns between stocks that pay dividends and those that don’t is far greater. Using data that Ned Davis Research has now updated through the end of May 2008, the numbers look like this:
Again, according to Ned Davis, the value of a $100 portfolio begun in 1972 that invests only in stocks that pay no dividend would be worth $215 at the end of May 2008. At the other end of the scale, that same $100 invested in dividend-growing stocks would now be worth $3,793—more than 17 times as much.
The performance difference of more than 8 percent annually is substantially greater than the dividend yield itself. This tells us it isn’t just the dividend per se that makes the difference. In my opinion, the real difference lies in the business discipline that paying a dividend imposes on a publicly traded company. Dividends are paid in cash, which means they must come from real profits if a company is to sustain them.
Despite this evidence of the overwhelming importance of dividends to investors, there are still many pundits who view dividends negatively. One common thread for this negative view is that, because they’re taxed, dividends are an “inefficient” way for a company to return profits to shareholders. Another view often stated by these pundits is that the company is in a better position than its shareholders to reinvest the profits. If the latter were true, we’d find that non-dividend paying stocks were handily outperforming the dividend payers (instead of the miserable under-performance that actually occurs).
The tax efficiency crowd says it prefers share repurchase programs to dividends. But share repurchase programs are considerably less transparent than dividends. Shareholders know when dividends are paid because they receive cash, but one typically learns only many months later whether a repurchase program, authorized by the company’s board, has actually been carried out. Further, many companies use share repurchase plans to buy shares for reissue to management as part of a stock option plan. When that happens, the profits are really flowing back to management, not to shareholders.
If I must pay some income tax on my dividends, it’s a modest price to pay for vastly superior performance.
Follow-up on Yield Plus
In my April column (“The Enhanced Yield Fiasco”), I covered the woes of investors in Schwab’s Yield Plus Fund, a so-called “enhanced-yield fund.” At the time, the share price had drifted from $9.70 down to $8.89 a share, and the fund assets had shrunk from $13 billion to about $6 billion. As I predicted, the damage had just barely begun. The share price of Yield Plus is now $6.28, and assets under management have shrunk to $173 million. For the year to date, performance is a negative 29 percent. Schwab must now defend against several class action lawsuits by investors claiming they were misled by marketing materials touting Yield Plus as a low-risk money market substitute. Perhaps it’s time for Schwab to take the fund out and shoot it.
