Stephen Anness: Should you be paying more attention to dividends?

The 1970s and 1980s, during a period of higher inflation and interest rates, dividends made up a significant part of the total return of the S&P 500 at 28% in the 1980s and 73% in the 1970s.

The appeal and success of growth-oriented strategies since the global financial crisis has meant many investors have forgotten – or are yet to learn – the value of dividends.

But a market environment in which dividends make only a small contribution to total returns constitutes a historical anomaly.

In the wake of the financial crisis, central banks ushered in an extraordinary era of quantitative easing that lasted more than a decade. It resulted in record low interest rates, which encouraged growth investing, with investors more interested in potential returns tomorrow (or even in 10 years) than actual returns today.

In the 2010s dividends contributed just 17% of the total return of the S&P 500 index. But go back in history and that figure is much higher – 28% in the 1980s and 73% in the 1970s.

The 1970s and 1980s were a period that saw higher inflation and interest rates than we have seen in recent years. In that environment, with debt expensive, the efficient allocation of capital mattered.

You wanted the comfort and tangible returns that came from companies that were growing steadily, whose returns were insulated from inflation and which distributed a decent proportion of those profits among shareholders. The same is true today.

You can live off dividend income or you can reinvest it. Over the past 60 years nearly 70% of the total return of the S&P 500 index has come from reinvesting dividends and allowing them to compound.

The discipline of dividends

One of the main attractions of dividends is that they force a company’s management to be disciplined. The market expects a business that has a track record of both paying and growing dividends to continue doing so.

Some shareholders might argue this money should instead be reinvested to help a business grow. There are obviously instances when this approach can make sense. As part of our balanced investment approach, we do own some companies that reinvest everything for growth, but only when we believe they really have a long runway for growth.

However our core focus is on businesses that return at least some of the money they make to their investors – and we certainly avoid organisations that burn through cash in the hope of hitting on the next big thing, or companies that continue to reinvest despite returns in their business falling.

Looking for certainty in an uncertain world

A company that demonstrates discipline, focus and an aversion to cash-burning over a sustained period may earn the august title of ‘dividend aristocrat’. This term describes a business that has raised its dividend for at least 10 years.

The respective cumulative returns from dividend aristocrats and high-growth stocks since the beginning of the decade illustrate the former’s reliability. 

Dividend aristocrats have held relatively firm during the turmoil of the past few years – whereas high-growth stocks have risen and fallen more sharply, lagging throughout much of last year and early 2023.

Dividend growth has also broadly kept up with inflation and it has been more stable in comparison to earnings growth.

Sustainability is key

Some might be tempted to populate their portfolio with the highest-yielding stocks.

Often, however, an extremely high yield relative to the market can be a sign of distress. The highest dividend payers one year tend to have the biggest dividend cuts in the next. And when a high-yielding company cuts its dividend this often leads to a sell-off in shares and the share price plunging, adding further pain to your portfolio.

Better to find companies paying prudent dividend yields and growing them consistently Some of our biggest holdings at present include British multinational 3i (paying 2.89% dividend yield), US healthcare provider UnitedHealth Group (3.34% dividend yield), and semiconductor manufacturer Broadcom (2.09% dividend yield).

Three very different stocks, but each has a solid history of dividend payouts. Each has generated double-digit dividend growth over the past three years and is well placed to preserve this record. That growing yield on top of potential long-term capital growth could make for an attractive return over time.

A strategy for the long term

It is not only businesses that can attract investors by striving to maintain dividend discipline.

As an equity income investment trust, we make a similar commitment. The board of the Invesco Select Trust has pledged to at least maintain our dividend level from year to year. The first three quarterly dividends of a specific year are normally equal in size, with the fourth potentially increased; quarterly payouts may also be enhanced with contributions from capital.

The bottom line is that the investment environment of the next 10 years is likely to be very different from that of the past 10.

The era of ‘easy money’ is over, and the value of good operators and capital allocators is earning fresh recognition. In our view, this makes equity income investing much more interesting.

Stephen Anness is Invesco’s head of global equities and the portfolio manager of the Invesco Select Trust plc Global Equity Income (IVPG ) share portfolio

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