Skip to main content

Sound Advice: April 7, 2021

The High Dividend Strategy: Pros and Cons

Let's start with the bottom line about investing in high dividend stocks: It works, but there are significant wrinkles.  A while back, I did a 20-year study of investing in high dividend stocks.  The approach was straightforward.  I began with the S&P 500 universe and divided it into 10 groups of 50 stocks each. 

The groups were arranged by dividend yield, highest to lowest, at the beginning of each of the years.  I then tracked the total returns (dividends plus capital appreciation) of these groups for the full period.

The results were illuminating.  The highest total returns were from the group with the highest dividend yields.  The returns then descended in perfect order down to the group with the lowest dividend yields.  What's more, the aggregate return from the group with the highest returns was greater than that of the Standard & Poor's 500 and its volatility over the period was lower.

That did not mean all stocks in the group of highest yielders did well.  Quite the contrary.  The main reason for these impressive returns was surprisingly strong performance from a few stocks that did far better than they were expected to.  The majority of the stocks in the top group did not do well, but the average return was increased dramatically by a handful of huge winners.  In contrast, the group of stocks with the lowest dividend yield was the poorest performer because there were a few losers with very bad results.

The high dividend yielders, as a group, had their best showings during the weakest market years.  That's not surprising since it's well known that generous dividends tend to buffer price erosion when the market hits air pockets.  One more thing: The average performance of each of the highest yielding stocks was only so-so.  It was only as a group that they stood out.

At the same time, I did a similar study of companies using price-earnings multiples instead of dividend yields.  As might be expected, those with the lowest multiples turned in the best returns, actually a bit better than those of the highest dividend yielders.  But there was a greater variation in returns from year to year and the returns from lowest to highest did not decrease in perfect order.

With both groups, unusually high and low returns from the outliers were what caused the average returns to end up where they were.

Since each group consisted of 50 stocks, efforts to come close to replicating the results of these studies would require holding approximately that many stocks or investing in an exchange-traded fund with a similar approach.  Keep in mind, too, that the study covered two decades, so even though the numbers work over that long a period it's entirely possible, if not likely, that there will be short periods in between when the returns lag the overall market.

No strategy works all the time, but for those who are patient this one seems to be well worth considering.  Even so, investors need to be wary of obvious areas of concern.  For example, utilities often come up as possibilities when investors are looking for high dividends.  With the prospect of higher interest rates ahead, however, that may be a yellow flag before considering same.

High dividend yielding stocks offer a worthwhile opportunity, but careful consideration is essential before pulling the trigger to buy.  Especially important is the need to buy a sizable group, not just a few.

 

N. Russell Wayne, CFP®

Sound Asset Management Inc.

Weston, CT  06883

 

203-222-9370

 

www.soundasset.com

www.soundasset.blogspot.com

 

Any questions?  Please contact me at nrwayne@soundasset.com

Comments

Post a Comment

Popular posts from this blog

Sound Advice: May 13, 2020

Reality Check On the heels of the market plunge of late February and most of March, investors did a sharp about-face in April, bidding up shares at one of the fastest rates in recent history.  Although this recovery probably provided at least temporary comfort from the plunge, it would be unreasonable to view the rebound as a sign that things are all better.  They are not. For one thing, we are now in the midst of earnings reason, when companies report their quarterly results.  Some may have good news for the March quarter, but as we move through the current calendar quarter, only a few will be able to show continuing improvement.  Against the broad backdrop of U.S. business history, the months just ahead will almost certainly prove to be among the worst, from the standpoint of year-to-year comparison. With more than 30 million people filing claims for unemployment insurance, it would be difficult to expect anything other than bad economic news.  Who knows how many of these
Post a Comment
Read more

Sound Advice: July 8, 2020

Jobs Are Up, But So Are New Infections Through the spring months, m ost of the economic data was extremely negative, with record declines in employment and consumer spending.  The speed of that decline had no modern precedent. We are now in a recession.   The shortest recession on record occurred in 1980 and lasted just six months.  Second place goes to a seven-month recession in 1918-19, which was tied to the Spanish flu pandemic.  The big question is: When will this recession end? Given surprisingly strong data in May, April may have been the bottom of this economic cycle.  If so, it will have been the shortest recession on record.  With massive support from the Federal Reserve, the federal government, and the reopening of previously closed businesses, employment surged unexpectedly.  At the same time, pent-up demand, stimulus checks, and generous unemployment benefits led to a reacceleration of commercial activity. Still, not all is rosy.   In his recent testimo
Post a Comment
Read more

Sound Advice: July 22, 2020

Fixed Income: In a Fix Typically, the construction of an investment portfolio has begun with an approximate balance of 60% in equities and 40% in fixed income instruments.   Fixed income generally means bonds, but that includes bond funds and exchange-traded funds holding bonds.   The equity portion is intended to be the driver of capital appreciation over extended periods of time and the fixed income portion is supposed to provide stable, albeit more moderate ongoing rates of return. The theory behind this approach is that as the time periods measured have lengthened, the relative risk of holding equities has diminished while the returns they have generated have been higher than those of other asset classes.   What equities do in the short term, even a year or two, is often anybody’s guess.    To the extent that fundamental analysis can help toward determining future equity values, investors need to look ahead three, four, five years or more before reasonably expecting t
Post a Comment
Read more