Key takeaways
Dividend grower equities may offer potential sources of total returns, as well as income to add to portfolios. Continued dividend growth may signal stable earnings and robust finances, marking them as high-quality companies.
Historically, dividend growers have shown:
- Sustained income through dividends, which contributes significantly to total returns and may help offset the effects of inflation.
- Improved long-term risk-adjusted returns compared to their benchmarks.
- Higher free cash flow and lower payout ratios than companies which simply have high dividend yields, indicating their ability to sustain dividends over time.
- Lower leverage than high yielders indicating stronger balance sheets.
- Typically, more robust performance compared to peers during market drawdowns.
- Characteristics of quality companies with fundamentals which may allow them to perform well through a range of economic conditions.
- Similar valuations to their benchmarks, although lower technology sector exposure has led to relatively lower than benchmark valuations for US dividend growers especially in more recent years.
Dividends as a potential source of return
The total return of any investment can be split into two components: price appreciation and income generation. In the case of equities this income component, in the form of dividends, plays a significant part in generating total returns - in fact, around half of the total returns from global equities are attributed to dividend income.
| Equity type | Dividend Contribution to Returns |
|---|---|
| Global Equities | 50% |
| US Equities | 35% |
When looking to build an equity portfolio many investors may find dividend growers an attractive option. Their ability to consistently grow dividends often signals profitability, healthy balance sheets, and good management.
Growers historically performed well
Companies which consistently grew their dividends historically outperformed their peers over the long run on a risk-adjusted basis. The outperformance arises from the underlying factors that give rise to their ability to make such pay outs. In the following charts, the S&P Dividend Aristocrats index represents US equities that have consistently grown their dividends historically (dividend ‘growers’). Similarly, from a global perspective, the MSCI World Dividend Growers Quality Select index is used to represent global dividend growers.
| Calendar Year Returns | US Growers | S&P 500 | World Growers | MSCI World |
|---|---|---|---|---|
| 2020 | 7.8% | 17.8% | -0.5% | 15.9% |
| 2021 | 25.1% | 28.2% | 21.4% | 21.8% |
| 2022 | -6.9% | -18.5% | -8.8% | -8.1% |
| 2023 | 7.6% | 25.75 | 11.1% | 23.8% |
| 2024 | 6.3% | 24.5% | 8.9% | 18.7% |
| Annualized Returns and Volatility Since 2008 | ||||
| Return | 10.5% | 10.7% | 9.2% | 8.2% |
| Volatility | 15.1% | 15.9% | 15.2% | 16.4% |
Historically, companies that consistently grew dividends have produced higher returns over the long-term than their comparable benchmark market index as shown in the previous table, alongside lower volatility.
Dividend growers did, however, underperform the broader market during the recent technology sector driven rallies, as technology companies tend to pay low, if any, dividends. However, the robust fundamentals of dividend growers saw them outperform their benchmarks during the downturns of 2008, 2011, 2015 and 2022 on an absolute basis.1
Dividend growers bear the same risks as other equities.
Focus on growth, not yield
The term ‘growers’ is significant in the context of dividends. Companies able to maintain growth in dividends typically have stronger fundamentals with better than average credit ratings and financial strength.
More specifically, dividend growers tend to have more robust balance sheets offering the capacity to withstand shocks.
Conversely, companies that have high dividend yields without growth in their dividend typically demonstrate lower cash flow generation, a lower return on equity, and higher leverage. In these cases, the high yield may be a warning that a firm may be paying out an unsustainably high proportion of its profits as dividends, as indicated by a higher payout ratio in the table to the right.
High payout ratios leave less cash available for reinvestment into the business and make it harder for companies to sustain dividends should they face a drop in earnings. Therefore, in the case of an unfavorable change in the business environment, the highest yielders may be among the first to make dividend cuts. This reduces total returns and can increase volatility. Moreover, dividend cuts are often viewed negatively in financial markets, and this may contribute to a decline in the stock price.
Dividend growers have historically exhibited higher annualized total returns than those companies with simply high dividend yields.
The table uses the MSCI World High Dividend Yield Index for global high yielding equities (‘high yielders’), and the S&P 500 High Dividend Yield Index for similar US equities.
| Equities | World Equities | US Equities | ||
|---|---|---|---|---|
| Dividend type | Growers | High Yielders | Growers | High Yielders |
| Dividend Yield | 2.57% | 3.66% | 2.64% | 4.88% |
| Payout Yield | 52% | 63% | 59% | 138% |
| Leverage | 1.5 X | 1.7 X | 2.3 X | 4.9 X |
| Ann. Return | 9.6% | 8.1% | 10.4% | 8.4% |
| Ann. Volatility | 14.0% | 13.0% | 16.7% | 20.2% |
| Free Cash Flow Yield | 6.6% | 5.2% | 3.4% | 3.3% |
Dividend growth as a signal of quality
Companies which show a propensity to grow their dividend payouts over time may be an attractive investment prospect through market cycles. The ability to sustain growth in dividends can often indicate strong fundamentals, including having a stable balance sheet and consistent earnings growth, as well as the profitability and available cash flow to maintain and grow dividends. These characteristics signal quality companies. The financial strength and robust balance sheets that allow dividend growers to grow their dividends can help these companies to navigate volatility in economic conditions and may lead to more robust performance during drawdowns.
Valuations of dividend growers
Price-to-Earnings (P/E) ratios are often used to value equities against both peers and their own historical levels.
On average, US dividend growers have had a P/E ratio of 0.98 times that of their benchmark since 2013 and global dividend growers a ratio of 0.82 times their benchmark since 2020,1 indicating relatively cheaper valuations. A significant driver of this has been their lower exposure to the technology sector. Information Technology companies often display relatively high P/E ratios due to their outsized investments in research and development leading to a strong market’s outlook for their future growth.
The exposure of the S&P Dividend Aristocrats index to the Information Technology sector currently stands at 3%, compared to 30% for the S&P 500 index.2