Some investors wrongly believe that being a dividend orientated investor means there’s reduced potential for capital growth.
But that is not the case. According to a study published by the Brandes Institute between June 1981 and 2015, high dividend-paying stocks delivered higher total returns than lower dividend-paying stocks partly due to the dividend return, and partly due to price growth.
The study looked at the five-year annualised rolling average returns of the largest 50% of stocks by market capitalisation during the period. It separated the equities into five different buckets, from highest to zero dividend yields.
The authors found that stocks with the highest dividend yields produced an average five-year annualised return of over 14%. Of this, 5.4% was the dividend return, 8.9% was the price return.
In comparison, companies that did not pay a dividend returned 7.2% annualised.
The authors of the study also found that the highest dividend-yielding stocks tended to experience lower price volatility. The rolling five-year standard deviation of returns for the high dividend yield bucket was around 16%. That’s compared to approximately 21.5% for the zero dividend bucket.
Based on the above observations, the authors of the Brandes study concluded:
“The combination of the power of the income component to drive returns, aligned with today’s market environment, may provide potentially attractive opportunities for long-term investors who own a globally diversified portfolio of dividend-paying stocks.”
The message is clear. High growth tech stocks may appear to be the best investments in today’s market, but over the long-term, high-quality income stocks can yield much higher returns. The combination of income and capital growth is potent.
That said, not all income stocks are created equal. Businesses with dividends that appear unsustainable should be avoided.
The sharp fall in market value that is often seen after a firm decides to cut its dividend distribution to investors can eliminate years of capital growth in a single day.
Therefore, one may be better off avoiding the market’s highest dividend yields and focusing on sustainability instead.
A higher than average, sustainable dividend yield from a high-quality business is the sweet spot. Unfortunately, these opportunities are few and far between.
The best way to prepare could be to keep a list of the market’s best dividend stocks and be ready to pounce when the opportunity arises.