Targeting high dividends: common sense or flawed promise?

But if you don’t want to take regular income from your investments, and re-invest it instead to maximise long-term growth, does this style of investing still make sense as a core part of a portfolio?

The income, or yield, from dividends varies from country to country. Not all companies pay dividends and some sectors pay much higher dividends than others. In the developed world, the UK has been a consistently large dividend payer. In the US, while some companies will pay regular dividends – Coca-Cola, Johnson & Johnson and 3M have increased their dividends for 50 or more consecutive years³ – many companies prefer to distribute profits to investors by buying back their shares.

Does a high-dividend strategy pay off in the long run?

While it seems intrinsically common sense that companies paying dividends would be more attractive, and perform better, this has not been the case since the mid-2002. High dividend-paying stocks have not outperformed the broad market. Over 2003-2018, world (developed) equities returned 7.68% per year in US dollars (without fees or costs) while high dividend stocks returned 0.44% lower per annum (7.24%). Although that may not sound a lot, that amounts to over 20% underperformance in that . In the UK, high dividends have underperformed the broad market return by 0.91% per annum over that same period, or 43% in total.

It’s important to bear in mind that high dividend yield is not necessarily a sign of a good company – declining share prices artificially boost the dividend yield and high payouts may not be sustainable. Given that, another way to look at dividends is to focus on companies that have consistently paid or sustained high dividends.

Using S&P’s ‘Dividend Aristocrat’ series, we look at how ‘good’ dividend payers have fared – those that sustainably increase dividends over time. In the US, only holding a basket of S&P 500 that have increased their dividend in every year of the previous 20 years, would have outperformed by an impressive 1.98% per annum over 2003-2018. But much of this outperformance came during the financial crisis in 2008.

Over the past five years, the strategy would not have outperformed, and buying in mid-2016 would have caused a significant underperformance versus the broad market. In the UK, a similar strategy of owning good dividend payers has certainly not delivered outperformance in recent years – quite the reverse. From October 2015 to December 2018, this strategy underperformed by an alarming 27.5%.

Why we won’t chase high dividends as a strategy

While a strategy of ‘buying good quality companies with high dividends’ sounds like a good strategy, it’s never that simple. Investing on simple mantras like this can often lead to significant underperformance, however simple it may sound.

When buying an investing style or factor like dividends or small companies, or a theme (ageing demographics), you need to do your homework. What other decisions are you unwittingly taking when you pursue these strategies? Often, a dividend strategy may be more defensive, be significantly overweight or underweight a handful of sectors (e.g. overweight financials, underweight technology), or have a different bias to small or large companies.

At Nutmeg, we use these style and factor tools from time to time, depending on our economic and market view. It can help inform our view, but put simply, blindly owning funds because they pay high dividends is not our strategy – nor will it ever be.

Sources

1. Macrobond (Bank of England)
2. Nutmeg analysis based on data from Morningstar as at 20 February 2019, across UK Equity Income, UK All Companies and UK Small Equity sectors
3. USA Today, These 25 companies have over 40 consecutive years of dividend hikes – 30th August 2018

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Past and future performance are not a reliable indicator of future performance.