Do Dividends Matter? (Dividend Investment Strategy Revisited)

April is Financial Literacy Month which is the perfect time to write a blog on dividend investment strategy.

Stock dividends are essential, but not all dividends are created equal. It’s vital to remember that the percent dividend your stock is paying is something to be aware of, but it paints only a small part of the picture.

Let’s examine a stock investment strategy that uses dividends as a component of total return. According to data from Morningstar/Ibbotson, dividends have contributed 42% of the annual average total return of the S&P 500 index from 1926 through 2018. Some stocks may pay no dividends, while others pay a very high one. This strategy eliminates the stocks that pay no dividend. In most cases, the very high payer will also be illuminated. An unusually high dividend may indicate a problem.

One strategy focuses on stocks that pay sustainable dividends and can increase the dividend regularly. A sustainable dividend simply means the company has the financial stability to pay the dividend through various economic periods. However, the ability of the company to increase dividends requires that company to continue to grow. As you would expect, the companies represented in this type of portfolio tend to be established companies that generate free cash flow and management that works toward growing dividends.

Another focus is to invest in stocks in various industries to help diversify the portfolio. For example, it’s not uncommon to have a portfolio of up to about 50 stocks.

Let’s assume you purchased a stock like Clorox Company at the peak of the 2007 market. You would have paid about $62 per share, and your quarterly dividend was 40 cents per share. That would equal an annual dividend of over 2.5%. However, due to a significant market decline after the 2007 market top, you watched your investment drop by 20% by March 2009. This was a wise investment if you understood what you owned and were not panicked into selling. Fast forward to March 3, 2022, the stock price is $145 per share (well off of the high) and has a dividend of $1.12 per quarter. That is about a 3.2% annualized yield based on the current price. However, keep in mind if you purchased the stock in 2007 at $62, you’re getting over 7.5% on the money you invested.

Additionally, you saw the share price rise significantly even after the decline from the highs. The dividend was not increased all at once but was steadily increased over time. When the stock was down, still received your dividends.

This is not a specific recommendation but an example of how a stock that pays and increases dividends can work.

Over time the dividend investment strategy may include reducing, increasing, adding, and eliminating holdings in the portfolio. The fundamental strategy remains the same and tends to have a low/moderate turnover in the portfolio (amount of trading in the portfolio). These stocks will still experience market volatility, although sustainable dividends tend to have more support than non-dividend payers. This is called “yield support”. Remember the stocks in this strategy are presumed to be able to continue paying the dividend even in a slower economic environment. Example: A $50 stock that pays $1.50 in annual dividends (3% yield) falls 15% to $42.50, but continues the $1.50 dividend, now has a yield of 3.5%. At some point the yield will help support the stock price.  Conversely, even stocks with no dividend may outperform this strategy in times of higher growth.

You can utilize this strategy using funds, unit investment trusts, or individual stocks. However, this is only one of the multiple strategies that are available. But, like all investments, you need to understand them before investing fully.

For more details and questions on this and other investment opportunities, please contact me.

March 2022