Many investors have largely ignored dividend stocks in recent years, and to be fair, it probably hasn’t hurt their portfolio returns!
For one thing, dividend yields have been historically low. In the early 1990s, the dividend yield paid by an S&P 500 index fund was about 4%.1 Since 2010, this yield has rarely topped 2%.1 The same is true for many of the longest-running dividend stocks in the market. It certainly makes sense that dividends were much more of a part of the average investor’s strategy when they were generally larger.
Another reason is that growth stocks have been the primary driver of stock market total returns over the past couple of decades. During the latest 10-year period, the U.S. stock market produced an average annual return of over 12%.2
But if you look deeper into the performance, you can see that the gap between growth stocks and dividend-paying stocks was huge. Let’s look at some numbers to illustrate this: During the 10-year period ending in 2022, growth beat dividends by roughly 2% per year.3 But it did so with a lot more risk!
To be clear, some growth stocks pay dividends. But they are the exception. Most companies growing at double-digit rates are more inclined to reinvest their profits back into the business than pay a dividend to shareholders.
The recent market downturn has been very hard on growth stocks—especially those that have been the best performers in the years leading up to it. For the first time in years, dividend stocks outperformed growth in 2022—and by a significant margin.4 Why is that?
Simply put, dividend-paying stocks tend to deliver more stable returns, even in turbulent markets, and many investors are actively looking for safety in their portfolios. For one thing, companies that pay dividends tend to be relatively mature businesses with consistent cash flows when compared to non-dividend stocks. Additionally, a dividend can help create a price “floor” in the stock of an excellent business.
Think of it this way—if market pressures push a dividend stock’s price lower, its yield will increase. Once the dividend yield rises to a certain point, investors swoop in and load up on cheap shares to lock in a high yield on cost, preventing the stock from going down too much.
The numbers show this volatility difference. A stock’s “beta” is a metric that shows how reactive it is to market movements. By definition, the broad market has a beta of 1.0. So, a stock with a beta greater than 1.0 means it is more volatile and has less stability than the overall market. Growth stocks tend to have betas greater than 1.0, while dividend-paying stocks often fall below that level. For example, the high dividend yield index’s beta is less than 0.8.5
Looking at risk another way, the returns of growth stocks are all over the place—one year up 27% in 2017, the next year down 3% (2018), followed by up 36% in 2019.6 This wild pattern of return computes to a standard deviation—which shows the variation of returns around the average return—of 17%, compared to just 13% for dividends for the 10-year period of 2012-2022.7 (As a comparison, the broad market standard deviation was 15% for the same period!)8
It’s also important to point out that while we’ve talked about growth stocks versus dividend stocks, growth and dividends don’t have to be mutually exclusive. In fact, the combination of a steady dividend and solid earnings growth can potentially deliver above-par results over time.
For example, tech giant Microsoft* grew earnings per share by 383% (or an average of 17% per year) over the last 10 years.9 At the same time, the company delivered dividend/share growth of 201% (or 12% annualized). Similarly, Texas Instruments* has had over 500% of 10-year cumulative EPS and DPS growth, roughly 20% per year, on average.10 Both show that some companies can potentially have high growth and pay a dividend.
Some investors have dismissed dividend stocks as “boring” income investments, especially during the bull market that started after the 2008 financial crisis. But as 2022 has shown, dividend stocks can be resilient in turbulent economic climates. With many economists predicting a recession in the near future, allocating capital to dividend stocks could make sense for some investors.
Importantly, these stocks are not just a place to “park” money while waiting out this storm. There are some high-quality companies that have produced dividend income and can potentially grow long-term wealth through stock price appreciation. But not just any dividend stocks. It’s important to focus on companies that are growing their businesses (and profits) and can potentially afford to pay and grow their dividends over time.