Dividends are essential for generating market returns, said WisdomTree analysts at a webinar on dividend investing earlier this week.
“The true cash flow in owning stocks comes from the dividends,” said Jeremy Schwartz, global chief investment officer at the New York-based wealth management and ETF firm. “It’s very unusual to see large dividend declines.”
Stocks with growing dividends generally outpace inflation over the long run, he added.
At the same time, though, share buybacks have also been a major component of equity returns, said Jeff Weniger, head of equity strategy at WisdomTree Asset Management, who moderated the discussion.
He pointed to research showing that, over the long term, share repurchases have surpassed cash dividends and become a major source of corporate payouts to shareholders—so that buyback portfolios have generated greater returns than their corresponding equity indexes in both the large-cap and small-cap space.
Share buybacks shrink the number of shares outstanding, or the so-called float, and consequently increase a company's earnings per share, even if its actual profits remain flat. They have been favored by both certain technology concerns that have shunned dividends and other companies with relatively cheap shares in the value sector. “Buybacks have been a very good value factor,” he said.
Matt Wagner, WisdomTree’s associate director of research, said that during the pandemic and even before, there was a significant reduction in buyback activity as companies held onto cash. “Now there is much more volatility [in buybacks],” he said.
Still, buybacks and dividends combined are a significant factor in market returns, he explained. By simply owning the S&P 500, he said, a shareholder gets about a 2.8% yield from dividends and buybacks alone, even if the stock values are unchanged.
Weniger noted that it’s been a “growth-led market for so long,” most recently fueled by “a lot of AI attention,” which has contributed to making dividend stocks “much cheaper” than they were a couple of years ago. This might be a good opportunity for the asset class.
On the international side, Schwartz asserted that Japanese companies are increasingly shareholder-friendly, maximizing values through growing dividends and buybacks. Shareholders can also find “deep value in emerging markets,” he said.
But you don’t have to go international to generate yield, said Weniger. “Most of the alpha generation that we are seeing is simply from not being in the companies that are diluting [your returns],” he said. The industry tends to talk about “the stuff we own,” he observed, rather than the dud stocks to avoid. “Ninety-nine percent of getting through this business of hitting 65 and retiring without headaches is just getting away from the cannonballs and the grenades,” he said.
A lot of those bombs can be dodged by staying with large-cap names, he acknowledged. More than 80% of the large-cap companies in the S&P 500 pay dividends, and over the long run those dividends have contributed roughly a third of the index’s total return.
“People often think that large caps means profitability and small caps are like lottery tickets,” quipped Wagner. But the biggest difference between the winning and losing stocks, whether large or small, is profitability, he said. “Research shows that, over the long run, this idea of investing in highly profitable businesses—both large caps and small caps—will generate returns,” he explained. “But the relative excess return is actually even higher for small caps than it is for large caps.”
The “quality factor,” as he called it, makes the difference across the spectrum of large and small companies. Whereas investing in unprofitable small companies and hoping for a payoff one day “does not work,” he emphasized. “You want to avoid those unprofitable segments of the small-cap space. Avoid them and you’ll do just fine.”