“Income strategies haven’t been viable for a long time; the yields today on bonds, REITs and most common stocks are not high enough to do that,” says Lewis Altfest, president of Altfest Personal Wealth Management.
Are Dividends Really So Great?
An old investment canard is that between 30% and 50% of the S&P 500’s returns have come from dividend payments alone. Yet Faber cites a Ned Davis Research study that found most dividend stock outperformance was an artifact of geometric indexing, a method that suppresses the performance of outliers within an index.
When index returns were recalculated using an updated arithmetic indexing method, much of the outperformance disappeared.
Dividend yield investing outperforms at times because it is related to value investing, explains Faber, but it is not synonymous with value investing. Selecting stocks based on dividend yield falls short of more broadly accepted value investing selection methodologies like price-to-earnings, price-to-book and price-to-sales.
There’s no independent explanation for why dividend stocks should outperform—paying a dividend has no positive impact on a stock’s price. “Even though dividend investing is popular, a lot of serious and successful investors don’t consider dividends to be that relevant,” says Ben Kirby, portfolio manager at Thornburg Investment Management. “Still, dividends are clearly a significant portion of total returns over time.”
When equity returns are decomposed along the five Fama-French factors, it makes no difference whether a company pays a dividend. Equities that share similar exposures to factors like value, size and profitability tend to perform similarly over time.
The movement of cash to shareholders via dividends or share buybacks does nothing to alter the underlying value of a company. Instead, the value of its equity declines, its cash on hand falls or its debts rise, and the investor’s cash stockpile grows to a matching extent. The stock owners’ wealth is unaffected by the dividend.
Yet investors’ demand for cash flow-yielding investments continues to drive the price of dividend stocks.
Valuation