Thanks to the record high values stocks have achieved over recent years, dividends may not have been given the level of attention they deserve. In fact, it sometimes seems that the majority of investors believe share price appreciation is their most important goal.
Looking back, the Standard & Poor 500 Index bull market began its longest upward rise in history beginning in 2009. After its meteoric climb was so rudely interrupted by the pandemic, the market seems to have returned to its upward path, blasting through the 20% gain off a low that is defined as a “bull market.” In the process of observing this trajectory, many investors have overlooked the importance of stock dividends and believe that the appeal of stocks lies primarily in their potential to increase in price.
Why should dividends be important to you as an investor?
The leveling effect of dividends:
Stock prices are often volatile (2020 was an all-too-clear reminder of that fact), fluctuating based on recent news and investor perceptions. Dividends, by contrast, are based not on perceptions, but on a company’s actual profits and cash availability, changing far less frequently than stock prices. With fewer changes, dividends have had the effect of leveling the total return on stocks. In fact, at certain periods in recent history, dividends accounted for more than 40% of the S&P 500’s total return.
The informational value of dividends:
When a company has consistently been in a position to pay dividends to investors, even increasing the size of their dividend, that can be an indication of good management and profitability. Remember, companies pay dividends only after covering operating expenses.
The compounding effect of dividend reinvestments:
When you reinvest dividends into additional shares of a company, future dividends will be paid on those new shares as well as the original ones. The effect becomes one of compounding or generating “earnings on the earnings.” This is particularly powerful because there are no commissions or fees on those reinvested shares.
Dividends in the form of stock buybacks:
Dividends are one way a company uses profits to reward investors, But another form of “sharing the wealth” comes in the form of stock repurchases, with a company buying back its own stock from investors. Sometimes, because the buyback has reduced the number of shares in circulation, the reduced supply results in an increasing price per share.
Price return vs. total return
It’s a matter of perspective. There are basically two different ways investors can look at returns on individual stocks, mutual funds, or exchange-traded funds. Price return considers only capital gain or loss without considering dividends. Total return captures both capital gains and losses and the income from dividends.
According to Hartford Funds, between 1960 and 2016, more than 80% of the total return of the S&P 500 Index can be attributed to the compounding of reinvested dividends. The same study found that companies which grew dividends experienced a high return relative to other stocks, with significantly less volatility! Sheaff Brock manages a Dividend Growth & Income portfolio that consists of a portfolio of stocks with an objective to generate current income and also grow the income over time.
It’s time to give dividends their due!