Bond yields are near historic lows, yet the need for income is near generational highs. Tony DeSpirito offers three reasons why company dividends matter for both growth and income seekers.
As populations are aging, the need for income is growing. Yet interest rates, and government bond yields, are at historic lows. These traditional income engines are falling short of investors’ needs, a scenario likely to persist as central banks hold rates near their lower bounds to prop up economies in the wake of the coronavirus crisis. The Fed has signaled its intent to keep U.S. rates near zero through 2022.
Equity income is an attractive, and I would argue a necessary, alternative. At the end of July, a 10-year U.S. Treasury yield of 0.55% compared to an S&P 500 dividend yield near 2%. Not only are stocks yielding more, but equity income has the potential to grow over time while bonds (true to their “fixed income” label) pay fixed coupons until maturity. Following are three more reasons to like dividends:
- Growth and income potential. Dividends do a lot of the heavy lifting in terms of the contribution to a stock’s total return across time. Over the past 30 years, reinvested dividends accounted for more than 30% of global stock returns.*
- A marker of strength. The regular payment of dividends is often an indicator of company fortitude. It is a strong statement when a management can still commit to a regular cash payment to shareholders after first paying all costs, interest and taxes, and investing for future growth.
- Resilience across cycles. Companies with a record of paying and growing their dividend tend to be better managed. Their CEOs do not want to cut the dividend, so they invest more conservatively in cap ex and M&A and run a more frugal balance sheet. These “dividend growers,” on average, also tend to be less volatile and historically have been able to deliver strong relative performance in all types of markets, as shown below.
Dividend growers exhibit resilience
Historical average return by dividend category, 1978-2019
Source: BlackRock. Data from 12/31/78 through 12/31/19. The investment universe is the 500 largest U.S. stocks by market cap. Dividend policy constituents are calculated on a rolling 12-month basis and are rebalanced monthly. Category returns are calculated on a monthly basis. See page 1 for category descriptions. A bear market constitutes a decline of 20% or more. A bull market is defined as the gains between bear markets, which are defined as increases of 20% or more. The aggregate return for the Overall, Bull Market and Bear Market periods is calculated as an annualized average monthly return for the specified market periods, where annualizing takes into account compounding. Shown for illustrative purposes only. Past performance is not indicative of future returns.