Investing Risks and Returns by Dividend Policies

There are thousands of publicly-traded companies whose stocks trade in the U.S. stock market. Each has its own policy about whether it pays dividends and how much if it does. What do their dividend policies tell us about the quality of their stocks as an investment?

Ned Davis Research has been studying that question using stock price and dividend data that extends back over five decades. We think their approach is pretty unique. Starting from January 1973, they consider how investments in several different groups of S&P 500 (Index: SPX) component stocks differentiated only by their dividend policies in the previous year have performed over time.

Here’s how they divided up the groups of stocks:

• Dividend Growers and Initiators: Companies that either started paying dividends or increased their dividends in the preceding year.
• Unchanged Dividend: Companies that held their dividends steady.
• Dividend Nonpayers: Companies that paid no dividends to their shareholders.
• Dividend Cutters: Companies that reduced their dividend payments in the preceding year.

They treated each group as if it were part of an equal-weighted index fund, in which stocks were reallocated among the different groups at the beginning of each year depending on what happened with their dividends in the preceding year.

For example, companies that increased their dividends in Year 1 would be grouped with the Dividend Growers and Initiators in Year 2, but if the company cut their dividends during Year 2, the company’s stock would be moved to the Dividend Cutters group in Year 3.

NDR’s analysts then measured the total investment returns for each of these categories over time, which includes the effects of both price changes and dividend reinvestment. They also measured the risk of holding each group, which they measured as the standard deviation of the monthly variance in the returns of their hypothetical funds. In the case of returns, higher values represent better performance, and in the case of risk, a higher standard deviation indicates a greater risk for investors. For the purpose of the study, no taxes or trading costs were considered.

We’ve created the following chart to visualize NDR’s results, which we took from a recent report produced by Washington Crossing Advisors. The data represents the annualized rate of return and the annualized risk for all these dividend categories from January 1973 through September 2024.

The study finds that dividend growers and initiators, the companies that either increased dividends or started paying them in the previous year, offer the highest annual returns at 10.4% with the lowest risk, although that risk is such that it doesn’t exclude the potential to have a negative year.

That compares with a 9.3% total return for all dividend paying companies of the S&P 500. For the entire S&P 500 itself, the total return drops to 7.9%. We should note that volatility, or risk, has been slowly increasing as each of these groups expand on the Dividend Growers and Initiators category.

Excluding Dividend Growers and Initiators however lead to both substantially lower returns and higher levels of risk for investors. Total returns drop to 6.9% when looking at the group of companies that held their dividends steady in the preceding year, while nonpayers only deliver 4.3% returns on average. Dividend cutters have averaged negative average annual total returns since January 1973, coming in at -0.6%.

What does that say about the quality of the underlying stocks? In a nutshell, a company’s ability to sustain and grow its dividends over time is a pretty good measure of its relative quality compared to companies that either don’t grow their dividends, don’t pay them, or in the worst case, cut them.

Assuming you invest by equal weighting them within your own portfolio. We wonder how different the results might be if they were capitalization weighted like the S&P 500 itself. That’s a question perhaps better directed to NDR’s analysts who presumably have the data they need to test drive that investing scenario!

Image credit: Cash Dividends by Nick Youngson on Picpedia.org. Creative Commons CC-BY-SA 3.0. Alpha Stock Images.