Swedroe: Investors Too Focused On Dividends

August 13, 2014

Evidence to the contrary notwithstanding, investors seem overly focused on dividend strategies, especially in times of low interest rates.

Despite the fact that financial theory has long held that dividend policy should be irrelevant to stock returns, one of the biggest trends in recent years has been individual investors rushing to buy dividend-paying stocks.

In some cases, it's a substitute for safer, but lower-yielding bonds. In others, it's because investors believe dividend-paying stocks are simply better investments. For example, the SPDR S&P Dividend ETF (SDY | A-71) now has $12.4 billion in assets under management, and the Vanguard High Dividend Yield ETF (VYM | A-94) has grown to about $8.6 billion.

With this recent popularity in mind, I thought it would be interesting to examine the difference in returns on the stocks within the S&P 500 that pay dividends and the ones that don't.

Through July 31, 2014, the average year-to-date return of the 425 dividend payers was 7.1 percent. The nondividend payers provided an average return of 8.1 percent, outperforming the dividend payers by 1 percentage point.

Looking at the last 12 months, the average return of the dividend payers was 24.1 percent, virtually identical to the average 24.0 percent return of the nondividend payers.

Keep in mind that high-dividend strategies are really value strategies, and over the long term, value stocks have produced higher returns than growth stocks. Also, of all the metrics generally used to value stocks (price-to-earnings, price-to-book market value, price-to-sales and price-to-cash flow), the dividend metric produces the smallest value premium.

The data in the table below shows the annual average returns from 1952-2013—the longest period for which data is available for all four metrics—for the highest 30 percent of stocks ranked by each value metric minus the annual average returns of the lowest 30 percent of stocks in that metric.

Note that the data is based on the total stock market. This matters because the P/B ratio is weaker in large-cap stocks, which dominate the total market. Data is from the Fama-French data series.

Annual Average Returns 1952-2013

Value Metric Average Annual
Return (%)
T-Statistic
D/P 2.17 0.87
B/P 4.43 2.54
CF/P 5.11 3.19
E/P 7.33 5.00

With the relationship among these value metrics in mind, let's take a look at the returns of SDY and VYM, both of which Morningstar categorizes as large value funds. We'll compare them with the return of the Vanguard Value ETF (VTV | A-95).

Year-to-date, SDY returned 2.8 percent and VYM returned 6.1 percent, an average return of 4.5 percent. VTX returned 5.8 percent, outperforming the average return of the other two ETFs by 1.3 percentage points. As another benchmark, the Dimensional Fund Advisors Large Cap Value Fund (DFLVX) returned 6.5 percent. (Full disclosure: My firm, Buckingham, recommends Dimensional funds in constructing client portfolios.)

Despite the lack of evidence or support from financial theory, investors seem to focus on dividend strategies, especially in times of low interest rates. This focus has led to less than optimal results.


Larry Swedroe is the director of research for the BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.

 

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