Thursday, May 16, 2019

From the Desk of David Burks – Dividends: An Important and Underrated Driver of Total Return

David Burks
Author position
Sr. Vice President | Equity Income Analyst

From the Desk of David Burks

Senior Vice President and Equity Income Analyst David Burks has been with Hilliard Lyons, A Baird Company, since 1983. David has been nationally recognized for his stock recommendations eleven times: seven times by Thomson Reuters and four by The Wall Street Journal. David has appeared regularly on CNBC over the years.

Dividends: An Important and Underrated Driver of Total Return

Dividends. Who doesn’t enjoy receiving dividends from the stocks that they own? As a shareowner it’s certainly rewarding to see a company that one owns prosper and distribute a portion of their earnings in the form of dividends. As investors we ideally would like to own attractive businesses that are managed in a manner that generate consistently higher earnings and dividends. Yet as tempting as it might be to receive dividends in cash, it can potentially be much more advantageous on a longer term basis to reinvest them instead.

Let’s consider the chart above to illustrate the point. In this example we assume one invests $10,000 in a Standard & Poor’s 500 index in 1990 and holds it until today, nearly 30 years later. The lower line demonstrates the total return an investor would have had over that period had they maintained their position and received the dividends in cash. Over this timeframe the original $10,000 would have grown to $83,495, a solid 7.1% annualized return. Yet, this return would also be considerably below the S&P 500’s historical average of nearly 10%.

The top line shows the total return had an investor reinvested their dividends over the same period. As one can see, the difference becomes increasingly significant the longer the time period due to the wondrous effects of compounding. The original $10,000 would have grown to $153,773, or a 9.6% annualized return. This is near the historical average of the S&P 500 despite the two severe bear markets that occurred during the period. In addition, not only was the end result over $70,000 higher, it was 84% higher, an enormous differential.

Stocks Offer Significant Long-term Potential

Our example reminds us that investing in equities can be a very effective strategy in creating long-term wealth. Stocks have historically generated the highest long-term returns of any asset class, outpacing bonds, cash, and precious metals. However, stocks are also inherently volatile and carry risk. Long term equity investing requires considerable patience and perseverance. One should not easily dismiss these factors. It can be difficult, very difficult, to stay committed to stocks during bear markets, corrections and recessions. We saw proof of that last fall. These periods inevitably will challenge an investor’s resolve, even when one recognizes that stocks traditionally have been the best performing major asset class longer term.

In addition, effective long-term investing in equities also requires investors to be able to delay gratification. Again, this is much harder than it sounds and requires considerable discipline. Also, it may be quite tempting to exit a position after a significant gain. However, by doing so, an investor could potentially be foregoing much larger long-term gains.

Dividends Can Boost Total Returns

With regard to dividends, they can potentially be more than an important source of income to investors. As our example demonstrates, dividends can also contribute to capital appreciation through reinvestment and the large positive impact of compounding over time. When reinvested, they can potentially act as an accelerant to the original investment. Having said that, this would most likely occur with companies that can consistently grow their earnings and dividends. We believe the reinvestment of dividends might also be particularly appropriate in tax advantaged accounts.

Dividends Can Offer Attractive Current Income

Finally, dividends can continue to be a valuable tool for those investors with current income needs. Of course every investor’s objectives, risk level and timeframe are going to differ. Our preference remains with companies that have demonstrated long term success in growing both their earnings and dividends.

We continue to believe dividends remain highly relevant to investors. According to our partners at Strategas, dividends have accounted for 25% of the total return in the S&P 500 from 1982 to 2018. While less than in prior periods due to the large increase in corporate stock buybacks, they continue to represent an important part of an investor’s potential total return, in our view. With an average dividend payout ratio of under 35% for the S&P 500 in 2018, we believe most of these companies remain well positioned to deliver ongoing dividend growth in the future.

 


IMPORTANT DISCLOSURES

Each client’s investment needs, risk tolerance, and goals are different. This newsletter is not meant to be advice for any specific investor. Nothing in it should be construed as an offer to sell, or a solicitation of an offer to buy, any securities. This should not be used as the sole basis for an investment decision. Any opinions or estimates are subject to change without notice. For information about how any of this information applies to your personal financial situation, please contact your Wealth Advisor.

Past performance is not a guarantee of future results.

Although the information provided to you in this newsletter was obtained or compiled from sources that we believe are reliable, J.J.B. Hilliard, W.L. Lyons, LLC, A Baird Company, cannot, and does not, guarantee that the information or data is accurate, timely, valid, or complete.

All investing involves risk, including the possible loss of principal. You should carefully consider investment objectives, risks, charges, and expenses of any investment before investing. Diversification and asset allocation do not guarantee a profit or guarantee against a loss. Note: It is not possible to invest directly in an index.

Stock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market or economic developments. The bond market is also volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect can be more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks.