Is dividend-only stock investing a reliable strategy?How To Invest
Across the advisor community, we often hear individual investors coming to their advisors infatuated with generating investment returns through high dividend-paying stocks. While this strategy may have been praised by industry experts at one point in time and even today, the data and evidence over the past several decades have shown that there are significant tradeoffs that we believe investors should be aware of when focusing on investing only in firms that pay dividends.
Dividend-paying stocks are sometimes seen as a ballast to a portfolio, particularly during periods of volatility, due to their ‘regular’ income stream. However, companies paying dividends have the flexibility to cut their dividends and this often coincides with economic downturns. In fact, more than half of dividend-paying firms cut or eliminated those payouts following a financial crisis1. More recently, in the first three quarters of 2020, dividends from each dollar invested in US markets decreased by 22% compared to the same period in 20192.
For stockholders who own dividend-paying shares, those payments arrive on a schedule (quarterly, in many cases). The cash to fund a dividend must come from somewhere, however. We know the price of a stock is potentially influenced by all expected future cash flows to shareholders. If cash is paid today in the form of a dividend, the stock price—and total market capitalization—of the issuing company may therefore fall, as hypothetical Portfolio A shows in Exhibit 1 below. That means, all else being equal, an investor who receives a dividend may also be left with a less valuable equity holding.
For illustrative purposes only. Assumes the stock price will fall by roughly the amount of the dividend and assumes no nondividend-related price movement.
Past performance is not a guarantee of future results. There is no guarantee investment strategies will be successful. Investing involves risks, including possible loss of principal. Investors should talk to their financial advisor prior to making any investment decision. There is no guarantee an investing strategy will be successful. Investing risks include loss of principal and fluctuating value. All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.
It's also important to call out that by focusing on only dividend paying stocks, an investor would be excluding 35-40% of firms from their investible universe3. This choice has a direct effect on the total portfolio’s level of diversification. Over the years, we have seen a global decline in the propensity of firms paying stock dividends out to shareholders. For instance, in 1927, 68% of US companies were paying dividends, while only 38% of firms paid in 2021 as can be seen in Exbibit 2 below4.
|Exhibit 2: Annual percentage of firms and market cap that paid dividends in the United States|
Source: Fama/French US Portfolios Formed on Dividend Yield. See the Index Description for more information regarding the indices shown.
While we cannot predict what the investing landscape will look like in the future, we can certainly lean on the historical data and trends within the investible dividend universe to make informed asset allocation decisions.