The Evidence Against Favoring Dividend-Paying Stocks

My research confirms what academic theory predicts: There has been no historical alpha among dividend-paying stocks, including those with a history of increasing dividends. Investors are better served by “tilting” allocations to factors that have historically outperformed (e.g., value).

One of the more popular strategies is investing in companies with a track record of increasing dividends. S&P has even created an index of “dividend aristocrats” that measures the performance of S&P 500 companies that have increased dividends every year for the last 25 consecutive years. The Index treats each constituent as a distinct investment opportunity without regard to its size by equally weighting each company.

Asset managers are aware of the well-documented behavioral preference of investors for dividend-paying stocks – despite the fact that this behavior is an anomaly from the perspective of classical financial theory, as Merton Miller and Franco Modigliani famously established that dividend policy should be irrelevant to stock returns. As they explained, at least before frictions like trading costs and taxes, investors should be indifferent to $1 in the form of a dividend (causing the stock price to drop by $1) and $1 received by selling shares. This must be true unless you believe that $1 isn’t worth $1. This theorem has not been challenged, at least in the academic community. Catering to the investor preference for dividends, investment firms have created ETFs and mutual funds that focus on buying the stocks of the dividend aristocrats.

We can observe the popularity of such strategies by looking at the AUM of some of the leading ETFs that invest in stocks with growing dividends:

  • Vanguard Dividend Appreciation ETF (VIG) with AUM of about $64 billion. The fund follows the S&P U.S. Dividend Growers Index, which is composed of large-cap stocks that have a record of raising dividends every year. Expense ratio of 0.06%.
  • SPDR S&P Dividend ETF (SDY) with AUM of about $23 billion. The fund provides exposure to U.S. stocks that have consistently increased their dividend for at least 20 consecutive years and tracks the S&P High Yield Dividend Aristocrats Index. Expense ratio of 0.35%.
  • iShares Core Dividend Growth ETF (DGRO) with AUM of about $23 billion. The fund provides exposure to companies having a history of consistently growing dividends by tracking the Morningstar US Dividend Growth Index. Expense ratio of 0.08%.