With interest rates remaining near historic lows, individuals in search of income may be looking for investment alternatives beyond U.S. Treasuries, whose real yields (factoring in inflation) remain negative. Dividend-paying stocks might be one such alternative.
Dividends are cash payments made by publicly held companies to investors. They’re a way for businesses to return some of their profits to shareholders. While dividend payments are usually relatively small and measured in pennies per share, they can add up over time. When reinvested back into the company, dividends can lead to especially strong performance results.
Dividend Payment Trends
Early last year, many dividend-paying companies reduced or suspended their dividend payouts due to the financial pressures caused by the pandemic. These included businesses in the financial, energy, real estate and consumer discretionary sectors.
With the financial markets recovering so quickly, however, dividends payments soon resumed, reaching a record high by the end of the year. The average annual dividend payment rose by 0.7% in the fourth quarter of last year to $58.28 per share. This marked the ninth straight year of record dividend payouts.
Historically, dividends have made up a large portion of total investment returns, accounting for approximately 40% of total U.S. stock market returns since 1930. For example, consider a hypothetical $100 investment made in the S&P 500 Index in 1970. Price appreciation would have grown this investment to $4,418 at the end of 2020, but reinvested dividends would have grown it to $19,687 — or more than four times the growth in price appreciation alone.
This is due in large part to the power of compounding returns. When dividends are reinvested, future earnings and dividends are paid on a higher account balance than if the dividends were simply cashed out.
A Value Stock Rebound?
Most companies that pay dividends are considered value, instead of growth, companies. These are businesses in relatively stable, less-cyclical sectors like consumer staples and utilities. Growth companies like high tech, on the other hand, usually don’t pay dividends.
In recent years, value stocks have underperformed growth stocks. The valuation gap between growth and value stocks at the end of 2020 was at a historical level — large-cap growth stocks traded at price-to-earnings ratio of 37.9, compared to a PE ratio of 21.7 for large-cap value stocks.
History has shown, however, that large disparities like this tend to even out over time — and this reversal can happen quickly. Given this, the current market environment could present attractive opportunities for investors in value, dividend-paying stocks.
Right for You?
If you are searching for investment income, dividend-paying stocks might be an attractive alternative to Treasuries if you’re willing to assume additional risk. If value stocks rebound in the future as some analysts are predicting, the payoff could be even greater.
Give us a call if you have more questions about dividend-paying stocks. We can review your investment objectives with you and help you decide whether types of stocks have a place in your portfolio.