From 2000 to 2009, a period often referred to as the “lost decade,” the S&P 500 Index produced a negative return. Thanks to the dot-com bubble burst in March 2000, stock investors once again turned to fundamentals such as P/E ratios² and dividend yields.³

FIGURE 3 summarizes the dividend yield for the S&P 500 Index from 1960–2023. According to Yale, the median dividend yield for the entire period was 2.90%, with yields peaking in the 1980s and bottoming in the 2000s. Today, some investors are increasingly seeking to reduce risk in their portfolios by shifting some gains from growth stocks into dividend-paying stocks.

This conclusion is counterintuitive: Why wouldn’t the highest-yielding stocks have the best historical total returns? Isn’t the ability to pay a generous dividend a sign of a healthy underlying business?

We’ll answer these questions in a moment, but we’ll begin by summarizing the methodology and findings of the study.

Wellington Management began by dividing dividend-paying stocks into quintiles by their level of dividend payouts. The first quintile (i.e., top 20%) consisted of the highest dividend payers, while the fifth quintile (i.e., bottom 20%) consisted of the lowest dividend payers.

FIGURE 4 summarizes the performance of the S&P 500 Index as a whole relative to each quintile over nine decades.

The best way to measure whether a company will be able to pay a consistent dividend is through the payout ratio.

Do Dividend Policies Affect Stock Performance?

In an effort to learn more about the relative performance of companies according to their dividend policies, Ned Davis Research conducted a study in which it divided companies into two groups based on whether or not they paid a dividend during the previous 12 months. It named these two groups “dividend payers” and “dividend non-payers.”

The “dividend payers” were then divided further into three groups based on their dividend-payout behavior during the previous 12 months. Companies that kept their dividends per share at the same level were classified as “no change.” Companies that raised their dividends were classified as “dividend growers and initiators.” Companies that lowered or eliminated their dividends were classified as “dividend cutters or eliminators.” Companies that were classified as either “dividend growers and initiators” or “dividend cutters and eliminators” remained in these same categories for the next 12 months, or until there was another dividend change.

For each of the five categories (dividend payers, dividend non-payers, dividend growers and initiators, dividend non-payers, and no change in dividend policy) a total-return geometric average was calculated; monthly rebalancing was also employed.

It’s important to point out that our discussion is based on historical information regarding different stocks’ dividend-payout rates. Such past performance can’t be used to predict which stocks may initiate, increase, decrease, continue, or discontinue dividend payouts in the future.

Based on the Ned Davis study, it’s clear that companies that don’t pay dividends or cut their dividends suffered negative consequences. In FIGURE 7, dividend non-payers and dividend cutters and eliminators (e.g., companies that completely eliminated their dividends) were more volatile (as measured by beta⁵ and standard deviation)⁶ and fared worse than companies that maintained their dividend policy.

Lowest Risk and Highest Returns for Dividend Growers and Initiators

In contrast to companies that cut or eliminated their dividends, companies that grew or initiated a dividend have experienced the highest returns relative to other stocks since 1973—with significantly less volatility. This helps explain why so many financial professionals are now discussing the benefits of incorporating dividend-paying stocks as the core of an equity portfolio with their clients.

Companies that grew or initiated a dividend have experienced the highest returns relative to other stocks since 1973—with significantly less volatility.

The Future for Dividend Investors

Trend 1: High Corporate Cash Could Bode Well for Dividends

In the aftermath of the financial crisis, corporations began accruing record profits, and their balance sheets swelled as a result. Cash on corporate balance sheets has nearly quadrupled since the early 2000s. Corporations can use this excess cash in a variety of ways, such as expanding their businesses or making acquisitions. While these options may be attractive in some environments, during uncertain times some corporations may be more cautious and choose to hold on to their cash in case of another economic downturn. Companies may also choose to use excess cash to initiate a dividend or increase their existing dividend payouts.

FIGURE 10 shows the confluence of two positive trends that could benefit dividend investors: high corporate profits for S&P 500 Index companies coupled with near record-low payout ratios. The average dividend payout ratio over the past 97 years has been 56.1%. As of December 31, 2023, the payout ratio stood at just 36.5%—leaving plenty of room for growth.

Trend 2: Relatively Low Bond Yields Could Bode Well for Dividends

Although bond yields have risen, they’re still low relative to historical levels. Dividend-paying stocks may be appealing to many investors who are seeking yield. For example, retiring baby boomers who are searching for income-producing investments and institutional investors seeking yield may find dividend-paying stocks to be an attractive option.

Retiring baby boomers who are searching for income-producing investments and institutional investors seeking yield may find dividend-paying stocks to be an attractive option.

As of December 31, 2023, 18% of the stocks in the S&P 500 Index have dividend yields higher than the 10-Year US Treasury Note (see FIGURE 12).

Trend 3: Financial Repression and Institutional Investors

The US Federal Reserve (Fed) held interest rates low in the aftermath of the Great Recession. They attempted to normalize rates from 2015–2018, then cut them again in 2019 and 2020. The Fed raised rates multiple times in 2022 and 2023 to stave off inflation; they’re considering rate cuts in 2024.

We generally think of monetary policy as a catalyst to help accelerate or decelerate economic activity, but it can also be used for other purposes. By keeping interest rates low, the Fed helped keep interest payments on the national debt low. In other words, low interest rates benefited not only businesses and consumers who wanted to borrow money, but also the biggest debtor in the world: the US government.

Low interest rates benefit debtors and punish savers. Investors who have money in CDs,⁷ money-market funds,⁸ and savings accounts⁹ were receiving startlingly low rates until recently. Meanwhile, low interest rates made it easier for the US government to make payments on outstanding debt. These lower debt payments made severe austerity measures less necessary in the short term. But the burgeoning level of US government debt could one day lead to such measures.

Low interest rates are especially problematic for institutional investors. How long can a pension plan with an actuarial discount rate of 6% or higher continue to accept 10-Year US Treasury bonds¹⁰ that yield around 4%?

Institutional investors who seek higher interest rates have numerous options, including high-yield bonds,¹¹ bank loans,¹² sovereign debt of foreign countries,¹³ REITs,¹⁴ and dividend-paying stocks.¹⁵

In fact, since 2008, some institutional investors have poured nearly $78 billion into equity-income funds while individual investors have withdrawn nearly $82 billion from them over the same time period (see FIGURE 13). It’s not uncommon for institutional investors to be ahead of the general public when it comes to investing, but how long will this striking disparity last?

¹ S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.

² Price/earnings “P/E” ratio is the ratio of a stock’s price to its earnings per share.

³ Dividend yield is a company’s dividend per share divided by its share price.

⁴ The Russell 1000 Index measures the performance of the large-cap segment of the US equity universe. It’s a subset of the Russell 3000 Index and includes approximately 1,000 of the largest securities based on a combination of their market cap and current index membership.

⁵ Beta is a measure of risk that indicates the price sensitivity of a security or a portfolio relative to a specified market index.

⁶ Standard deviation measures the portfolio’s total-return volatility. A higher standard deviation indicates greater historical volatility.

⁷ A CD (certificate of deposit) is a savings certificate entitling the bearer to receive interest. A CD bears a maturity date, a specified fixed interest rate and can be issued in any denomination. CDs are insured up to $250,000 per depositor by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Association (NCUA).

⁸ Money market funds are not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although the funds seek to preserve the value of the investment at $1.00 per share, it is possible to lose money by investing in the funds.

⁹ A savings account is an account provided by a bank for individuals to save money and earn interest on the cash held in the account. Savings accounts are typically insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000.

¹⁰ US Treasury Bonds are backed by the US government and are guaranteed as to the timely payment of principal and interest. This guarantee does not apply to the value of fund shares.

¹¹ High-yield securities, or “junk bonds,” are rated below-investment-grade because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities.

¹² Bank loans are below-investment-grade, senior-secured, short-term loans made by banks to corporations. They are rated below-investment-grade because there is a greater possibility that the issuer may be unable to make interest and principal payments on those securities.

¹³ A government bond is a bond issued by a national government denominated in the country’s own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Timely payment of interest and principal payments on sovereign debt is dependent upon the issuing nation’s future economic health and taxing power.

¹⁴ A REIT, which stands for Real Estate Investment Trust, is a company that owns or manages income-producing real estate. REITs are dependent upon the financial condition of the underlying real estate. Risks associated with REITs include credit risk, liquidity risk, and interest-rate risk.

¹⁵ A stock is an instrument that signifies an ownership position (called equity) in a corporation, and represents a claim on its proportional share in the corporation’s assets and profits. Dividends are a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. There are no guarantees connected with the dividend payouts for dividend-paying stocks.

Important Risks:  Investing involves risk, including the possible loss of principal. • Fixed income security risks include credit, liquidity, call, duration, and interest-rate risk. As interest rates rise, bond prices generally fall. • For dividend-paying stocks, dividends are not guaranteed and may decrease without notice. • Foreign investments may be more volatile and less liquid than U.S. investments and are subject to the risk of currency fluctuations and adverse political, economic and regulatory developments. • Different investment styles may go in and out of favor, which may cause a fund to underperform the broader stock market.

This information should not be considered investment advice or a recommendation to buy/sell any security. In addition, it does not take into account the specific investment objectives, tax and financial condition of any specific person. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. This material and/or its contents are current at the time of writing and are subject to change without notice.