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Market View

Dividend payers have many virtues and may weather a correction better than most.

A soft economy, shaky corporate revenues, and above-average equity valuations have some investors concerned about a possible market pullback in the short term. As for the long term, investors may question whether stocks will provide the kind of performance they have in the past. Given this environment, where might investors find the possibility of some stability and relatively attractive total returns?

Take a look at Chart 1. It shows that the total returns on stocks that pay dividends historically have been higher and much less volatile than those that do not. A number of factors account for this relatively attractive risk-adjusted performance.  

First, dividend payers put cash in your pocket on a regular basis. Those payments have the virtue of locking in a portion of your return and at least partially offsetting price volatility.

Historically, this has paid off, especially in a down market. A paper from S&P Dow Jones Indices, citing research from academics Kathleen P. Fuller and Michael A. Goldstein, notes that dividend payers tend to perform better than non-payers, especially in market declines. Fuller and Goldstein examined returns in both rising and falling markets, between January 1970 and December 2007. Their key finding was that during down markets, dividend-paying stocks beat their non-paying counterparts by 1–2% per month.1

This also helps to explain their performance over the long run. After all, one way to win in the market is by not losing. So, by reducing the downside, dividend payers have a smaller deficit to make up when the market recovers. The other factor at work here is compounding. While reinvested dividends play a less critical role over short time horizons, their impact on total returns becomes more and more pronounced as time passes. 

In fact, decade by decade, reinvested dividends historically have accounted for around 45% of cumulative returns since the 1930s, according to Strategas Research. And, again, as Chart 1 indicates, dividend payers historically have produced significantly better returns than non-payers over the long term.

 

Chart 1. Dividend Payers Have Provided Greater Returns, and with Lower Risk Potential
Total return and standard deviation for members of the S&P 500® Index, 01/31/1972–03/31/2015

Source:   Ned Davis Research, Inc. © Copyright 2015 Ned Davis Research, Inc.
See NDR disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo. Average annual returns and annualized standard deviation are based on the subcomponents of the S&P 500 Index, equal-weighted on a total return basis, 01/31/1972–03/31/2015. The chart is based upon an equal-weighted geometric average of the historical total return and standard deviation of dividend-paying and non-dividend paying stocks for the period 01/31/1972–03/31/2015. The chart uses actual annual dividends to identify dividend-paying stocks and is rebalanced annually. The dividend policy for each stock is determined on a rolling 12-month basis. The periods shown do not represent the full history of the S&P 500 Index.
Past performance is no guarantee of future results.  For illustrative purposes only and does not reflect any specific Lord Abbett mutual fund or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.

 

Given these virtues, investors may be tempted to look for stocks with the highest dividend yields. But, as Chart 2 suggests, this would be a mistake. The top dividend-yielders have lagged not only dividend payers but non-payers as well.

This is where the virtue of a professionally managed strategy becomes evident. While some of the top payers may merit investment, a high dividend yield often is a sign of fundamental distress, with a steep decline in stock price—as opposed to an increase in the dividend payout—driving up the yield. Careful analysis of company fundamentals, however, can enable professional managers to distinguish likely winners from likely losers. 

 

Chart 2. Stocks with the Highest Dividend Yields Have Underperformed
Growth of $10,000 investment in S&P 500, 01/31/1972–03/31/2015

See NDR disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo. Average annual returns and annualized standard deviation are based on the subcomponents of the S&P 500 Index, equal-weighted on a total return basis, 01/31/1972–03/31/2015. The chart is based upon an equal-weighted geometric average of the historical total return and standard deviation of dividend-paying and non-dividend paying stocks for the period 0/31/1972–3/31/2015. The chart uses actual annual dividends to identify dividend-paying stocks and is rebalanced annually. The dividend policy for each stock is determined on a rolling 12-month basis. The periods shown do not represent the full history of the S&P 500 Index.
Past performance is no guarantee of future results.  For illustrative purposes only and does not reflect any specific Lord Abbett mutual fund or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment. Dividends are not guaranteed and may be increased, decreased, or suspended altogether at the discretion of the issuing company.

 

Professional management also offers more flexibility than rules-based vehicles, enabling investors to capitalize on opportunities that would otherwise be missed. For example, as Barron’s pointed out in its latest issue (“Dividend ETFs Tend to Shun Tech Sector,” Barron’s, May 2, 2015), many dividend-focused exchange-traded funds (ETFs) limit their holdings to companies that have paid or increased dividends for many years. As a result of this strict, rules-based approach, they own almost no technology stocks.

But it is in the technology sector where the most rapid growth in dividends is occurring. In the S&P 500® Index, for example, the technology sector now accounts for 15% of the index’s dividend payout, up from just 5.6% in 2007, according to S&P index analyst Howard Silverblatt.2

Barron’s notes that in April 2014, Apple hiked its payout by 10.6%, making the company the largest dividend payer in the market. But none of the largest dividend-payer ETFs own the stock because their rules require years of consistent and/or growing payouts.

So, they may not own Apple or others in the technology sector for many years to come. One of the largest dividend-payer ETFs, for example, limits itself to companies that have paid dividends for 20 years, meaning that Apple may not qualify until 2032.

As an alternative, investors should consider professionally managed strategies that have the flexibility to consider the full spectrum of dividend payers and capitalize more fully on the long- and short-term benefits of dividend-paying stocks.

 

1Aye M. Soe, “Dividend Investing and a Look Inside the S&P Dow Jones Dividend Indices,” S&P Dow Jones Indices, March 2013.
2Chris Dieterich, “Dividend ETFs Tend to Shun Tech Sector,” Barron’s, May 2, 2015.

 

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The Lord Abbett Affiliated Fund Class A invests primarily in dividend-paying stocks of large U.S. companies. Access performance and portfolio information.

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