Even though financial theory has long held that dividend policy should be irrelevant to stock returns, there has been a rush in recent years to invest in dividend-paying stocks. This trend has been fueled both by media hype and the current regime of interest rates, which are well below historical averages.
The low yields on safe bonds available during the past seven years have led many once-conservative investors to shift their allocations from safe bonds to much riskier dividend-paying stocks. This has been especially true for individuals who take an income—or cash-flow—approach to investing as opposed to a total return approach, which I believe is the right one.
The heightened interest in dividends also arises from investors who believe that dividend-paying stocks make better investments. The SPDR S&P Dividend ETF (SDY | A-76) now has $13.1 billion in assets under management and Vanguard's High Dividend Yield ETF (VYM | A-98) has about $11.2 billion in AUM. Together, that's almost $25 billion invested in just these two dividend strategies.
Given the interest, and extremely rapid growth in AUM of these funds, I thought it worthwhile to review the recent performance of the dividend and nondividend-paying stocks within the S&P 500.
Dividend Vs. Nondividend
Over the first six months of 2015, the average return to the 421 dividend-paying stocks in the S&P 500 was 0.0 percent. The average return to the nondividend-paying stocks in the index was 6.5 percent. Over the past 12 months, the gap was even wider. The dividend-payers returned 4.7 percent, underperforming the nonpayers (which returned 13.1 percent) by 8.4 percentage points.
In case you may be thinking this underperformance was just a very recent occurrence, we'll also look at returns for both 2014 and 2013. In 2014, the 423 dividend-paying stocks in the index (equal-weighting them) returned 14.0 percent. Nondividend-paying stocks returned 14.4 percent, an outperformance of 0.4 percentage points. In 2013, dividend-paying stocks in the index (again equal-weighting them) returned 40.7 percent compared with 46.3 percent for the nonpayers.
From January 2013 through June 2015, each dollar invested in the dividend-paying stocks grew to $1.60. Each dollar invested in the nondividend-paying stocks grew to $1.89, a cumulative outperformance of 18 percent.
The trend goes back even further. For the five-year period ending July 20, 2015, SDY returned 14.5 percent and underperformed the 16.7 percent return for Vanguard's 500 Index Fund (VFINX) by 2.2 percentage points per year.