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.
Popularity Kills Strategies
It's also important for investors to understand that the popularity of a strategy correlates negatively with future expected returns. And the popularity of dividend-paying strategies has altered their very nature. Dividend-paying strategies historically have been value strategies.
Yet Morningstar shows that, as of June 30, 2015, the price-to-earnings (P/E) ratio of SDY was 19.3, higher than the P/E of 18.3 for the SPDR S&P 500 ETF (SPY | A-99). Higher price-to-earnings forecasts lower future returns. The price-to-book (P/B) ratios are virtually identical: 2.4 for SDY and 2.5 for SPY.
There's an anomaly at work here. Even though many investors seem concerned about the high current valuations of the market, those same investors have been rushing to buy stocks with even lower expected returns (almost certainly, however, without knowing this is the case).
In summary, 2008 should have taught investors that dividend-paying stocks are not alternatives to safe bonds. Unfortunately, far too many investors failed to learn this lesson, and that could prove very costly when the next bear market arrives. The issue is compounded by the fact that the popularity of dividend strategies has led to valuations above those of the overall market. Forewarned is forearmed.
A Case For Active Management?
I thought it would be worthwhile to point out that while the S&P 500 index returned 1.2 percent in the first half of 2015, there were 10 stocks within the index that outperformed it by at least 35.9 percent. The table below shows the price-only returns for the top 10 stocks.
|Company (Ticker)||YTD Return (%)|
|Netflix Inc. (NFLX)||92.3|
|Cigna Corp. (CI)||57.4|
|Hospira Inc. (HSP)||44.8|
|Aetna Inc. (AET)||43.5|
|Skyworks Solutions (SWKS)||43.2|
|Electronic Arts (EA)||41.4|
|Amazon.com Inc. (AMZN)||39.9|
|Altera Corp. (ALTR)||38.6|
|Hasbro Inc. (HAS)||36.0|
|Kraft Foods Group (KRFT)||35.9|
This group of stocks certainly provided plenty of opportunity for active managers to generate alpha. All that's required is to overweight these winners. While readers of my articles know I don't make market or economic forecasts, I'm willing to go out on a limb and predict that, despite this obvious opportunity, the majority of active managers will once again underperform, and they'll come up with a laundry list of excuses explaining why they failed.
Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.