I might be preaching to the choir, but sometimes the choir needs preaching to. This sermon reveals more evidence that dividend stocks are the best stocks to own. The evidence is worth sharing.
The November/December 2016 issue of the Financial Analysts Journal featured a provocative (at least to me) article titled “What Difference Do Dividends Make?” by C. Mitchell Conover, CFA, CIPM, Gerald R. Jensen, CFA, and Marc W. Simpson, CFA. No surprise here: dividends make quite a bit of difference, and all for the positive.
Conover et al. evaluated dividend-paying stocks through the years and identified two major findings: One, high-dividend payers have the least risk, yet return 1.5% more annually than non-dividend payers. Two, dividends benefit investors who own growth and small-cap stocks, the stocks of companies usually thought to benefit most from reinvesting cash flow.
The authors’ findings support several conclusions about dividend investing I’ve long-ago arrived at after years of investing.
Dividend-paying stocks significantly reduce portfolio risk, independent of investment style. The finding is true for value and growth portfolios, as well as small-, mid-, and large-cap portfolios. In other words, regardless of investing style, put dividend-paying stocks at the top of your short list of stocks.
Dividend Investing and Risk
In addition, Conover et al. found (as have I) that high-dividend-yield portfolios are lower-risk portfolios. They found that an average yield of 4.3% or higher offered the least risk of all the investment portfolios they tested. If you want lower price volatility, a portfolio of high-yield stocks is the way to go.
But what about high-growth, non-dividend-paying stocks like Amazon.com (NASDAQ: AMZN) or Facebook (NASDAQ: FB)? Surely, these high-fliers are better off reinvesting all earnings and eschewing dividends for the sake of the future?
Conover et al.’s data suggest otherwise. They find that over time dividend-paying stocks have higher returns than non-dividend-paying growth stocks. Investors wrongly presume that high-growth companies have high-return internal investment opportunities, and thus dividend payments would detract from investment return. That’s not the case.
Most surprisingly, Conover et al. found that growth investors targeting average-size or below-average-size companies could have quadrupled returns by investing in high-dividend-yield stocks rather than non-dividend stocks. What’s more, they found that this remarkable increase in returns was accompanied by a substantially lower risk. (Tesla (NASDAQ: TSLA) and Facebook investors take note.)
Consistent Drumbeat for Dividend Investing
Finally, Conover et al.’s research also suggests that the Dogs of the Dow, a popular investment strategy focused on buying the highest-yield Dow 30 stocks, would be more successful if applied to a group of stocks that included companies of average and below-average size.
“What Difference Do Dividends Make?” is consistent with other positive dividend research, most notably the 2003 Financial Analyst Journal article titled “Surprise! Higher Dividends = Higher Earnings Growth” by Robert Arnott and Clifford Asness. (I’m well acquainted with the Arnott/Asness article.) In short, dividend investing is the best strategy for generating higher returns with less risk.
Over 80 years ago, the father of value investing (and the father of dividend investing) Benjamin Graham and his co-author David Dodd presented the first compelling argument for dividends in their classic text Security Analysis. Graham and Dodd argued that investors should prefer a sure dividend to the risk of allowing the company to reinvest it. They also presented evidence that dividends contribute to reliable returns, buffer capital losses, reduce portfolio volatility, and lower the risk of overpaying for a stock.
I’m well-versed in arguments supporting dividend investing. That said, I’m always invigorated when the arguments are further buttressed by new research. “What Difference Do Dividends Make?” further buttresses the case for, and my belief in, dividend-paying stocks.