High-Dividend Yield Strategy under the Microscope
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Today’s ultra-low interest rates have propelled investors into a frantic quest for higher income. In response, high-dividend yield stocks have become the favorite recommendation of a host of advisors. Yet, an undue focus on income alone obscures the irreducible fact that long-term investment success is based on the total return of a portfolio including both income and capital growth.
This raises two questions. First, given its income focus, how has the total return of a high-dividend yield strategy fared relative to the market overall? Second, how does its total-return performance compare to the returns of other possible stock-selection strategies?
A high-dividend yield strategy is a systematic methodology to buy and hold stocks where the dividend is high in relation to the stock’s price. In effect, it is a strategy that selects value stocks since it is actually the low price of the stock relative to the dividend that primarily creates the high yield. As evidenced in the following graph, from 1952 through 2011, $1.00 invested in high-dividend yield stocks1 (in orange) grew to $1,227, more than three times the $386 in the S&P 500 (in red).
Over this period, high-dividend yield stocks returned 12.6% annually, far outpacing the 10.4% of the S&P 500. The US market is not alone in evidencing a return premium from high-dividend yield stocks. A global review2 of dividend yielding stocks in 21 countries over multiple decades found that high-dividend yield stocks outperformed low-yield stocks in 20 of the countries with an overall average premium of 4.1% a year.
However, a high-dividend yield strategy is just one variant of stock strategies that select value stocks and there is considerable evidence as well as theoretical support that value stocks outperform both growth stocks and the market over longer periods of time. (See our July 2009 commentary, Beating the Market.) In this context, the “yield” premium ascribed to high-dividend strategies is actually a “value” premium.
Other value strategies3 select stocks based on high earnings or high cash flow in relation to price, as well as high book value of equity relative to market value. As evidenced in the following chart, over the period 1952 to 2011, high-dividend yield stocks, although outpacing the overall market, returned less than value stocks selected on the basis of earnings, cash flow or book value.
1. The high dividend yield portfolio was created using data from Professor Ken French’s website. The high-dividend portfolio is based on the top 30% of capitalization weighted dividend paying stocks rebalanced annually.
2. Credit Suisse Global Investment Returns Yearbook 2011. February 2011. Credit Suisse Research Institute.
3. All portfolios were created using data from Professor Ken French’s website based on the top 30% of capitalization weighted stocks measured on earnings to price, cash flow to price, and book to market value.