Thursday, September 28, 2017

Performance of Dividend Payers versus Non Dividend Payers in S&P 500

I recently obtained the data behind the performance behind dividend and non dividend payers in the S&P 500 per year. This is a calculation performed by the index committee that separates members of S&P 500 into dividend paying and non dividend paying, and then equally weighting those portfolios. The performance of an equal weighted portfolio of dividend stocks is compared to the performance of an equal weighted portfolio of non dividend paying stocks.

Source: S&P/Dow Jones Data

The number of dividend paying stocks has varied over time. Currently, there seem to be 419 companies paying a dividends, out of 505 members of the S&P 500 index ( the difference is due to the inclusion of multiple share classes on the same company – e.g. GOOG and GOOGL)
Most companies paying a dividend are in mature industries. Most dividend stocks tend to be value stocks, which tend to decline by less during bear markets but still provide sufficient upside during bull markets.

Non-dividend paying companies are usually riskier growth type companies, which tend to fall faster and further during bear markets, but can deliver higher returns during bull markets. For a retired investor, there is a higher sequence of returns risk with non-dividend paying stocks, due to the reliance on capital gains only and the volatility in share prices.

It looks like dividend stocks had higher total returns than those of non-dividend paying stocks during that time period. In addition to that, they fell by less during the dot-com bust and the financial crisis.

Source: S&P/Dow Jones Data

A $100 investment in the dividend paying stocks of the S&P 500 was worth $381.17 by August 2017.

The same original investment in the non-dividend paying stocks of the S&P 500 was worth $349.29.

Looking at annual performance, it looks like the past five years have been characterized by non dividend paying companies doing better. Those short-term numbers are noise, as those ebb and flow over time, swaying the weak hands into capitulating from their strategy and embracing another one.

Investors in non-dividend paying stocks had to endure higher volatility of returns during the time period. For example, non-dividend paying stocks fell by more in 2001 – 2002 and 2007 – 2008.

The surprising fact is that investors in dividend stocks lost money only in 3 out of 16 years, while investors in non-dividend paying stocks lost money in 5 out of 16 years. Dividend paying companies did better than non-dividend paying companies in 9 out of the 16 years. This speaks to the fact that dividend stocks tend to be more mature, and typically are of the value type. Non-dividend paying securities are usually riskier, and are more susceptible to being overvalued by euphoric speculators. The one notable event where it pays to own non-dividend paying stocks is right at the beginning of a new bull market. This is evident by the high performance in 2003 and 2009 for non-dividend paying stocks. Of course, your guess as to when a new bull market starts is as good as mine.

Investors in companies that paid no dividends who had to live off that portfolio, would have suffered more than people who focus exclusively on more stable dividend paying companies. This increased sequence of return risk in non-dividend paying companies was illustrated in an article where we compared returns on a dividend paying stock versus the return on a non-dividend paying stock, which had similar total returns over the study period. Sequence of return risk is a fancy way of stating that you have a higher chance of running out of money in retirement if you have to sell shares at low prices in order to to fund retirement expenses.

Dividend paying companies generate a lot of excess cashflows, are more stable and tend to do well throughout the economic cycle. Hence it is no surprise that they tend to generate returns that are more stable. Of course, the most stable portion of returns is the dividend, which is always positive, tends to rise above the rate of inflation over time, and allows you to avoid selling stock to fund your lifestyle in retirement. Having to sell stock when prices are low during a bear market is recipe to increase the chance of depleting your portfolio.

Some investors view dividends as tax inefficient. I don't buy into this argument, because a large portion of investor assets are owned in tax-deferred accounts anyways ( hence, just put those dollars in a tax-deferred account). The problem is that by avoiding dividend paying companies, investors are increasing the risk profile of their portfolios. This means that they have a higher chance of potentially running out of money in retirement, because they are earning returns only through capital gains. If you have been around for more than a few years, you know that stock prices do not move up nicely in a linear fashion every year. There are a lot of gut wrenching moves that test the patience of every investor. You may be basing your retirement on 4% annual returns, that may not be there at the specific time frame that you need that money for. With dividend payments, the retirees can focus on the stream of income, and can ignore stock market fluctuations.

In my investing, I try to minimize taxes as much as legally possible. In my case this means taking advantage of any tax-deferred account within my reach such as 401 (k), Roth IRA, SEP IRA, HSA etc. However,  my focus is on earning the reliable returns to live off in retirement first, and taxes are a secondary consideration after that. You should not let the tax tail wag the investing dog.

The results are not surprising. In the past, dividend stocks have been found to have done better than non-dividend paying stocks. This relationship doesn’t hold true in all decades of course.

Source: Seeking Alpha

The returns tend do fluctuate from decade to decade of course:

Source: Seeking Alpha

On a side note, I am surprised that the ETF vendor industry has not started funds focusing on S&P 500 dividend payers and funds focusing on S&P 500 non dividend payers. I have some wealthy acquaintances that would gobble up the non-dividend portions into taxable accounts, and place the dividend portions in tax-deferred accounts.

Dividend income is more stable than capital gains
Should dividend investors hold non-dividend paying stocks?
John Bogle Likes Dividends
How to properly weight dividend portfolio holdings
Should Dividend Investors own Non-Dividend Paying Stocks?

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