Global dividend yields are currently attractive relative to other sources of investing income, especially in the context of low interest rates and low government bond yields in many markets. Moreover, it remains a very traditional investment style. Dividends have been around for a very long time with the first-ever invented by the Dutch East India Company in the early 17th century.
As developing markets mature, increasingly companies in those regions are beginning to issue dividends. Asia, for example, is becoming more important in this regard. In my view, focusing on dividend yields can be a useful barometer for identifying quality companies that are disciplined and efficient in their capital allocation and cash flow management.
I am sceptical we are in the foothills of a bull market. In my view, valuations, interest rates and trends related to corporate margins as well as demographics do not point to an equity bull market that is likely to endure for a substantial period of time, as seen in the recent past. This is despite some examples of ‘good news’; global economic ‘recovery’ is underway, the growth dynamics of the developing world are positive and monetary policy is supportive of asset prices. Should this cyclically improving environment be undermined by the structural problems outlined earlier, I believe investors will come to prize highly the certainty of a dividend yield.
The benefit of compounding
For the long-term investor, attractive equity returns are derived not simply from the receipt of dividends but from the accumulation of shares as a result of the reinvestment of those payouts. The compounding of investment returns by way of income reinvestment can be a powerful driver of equity returns over the long run.
Investors should also benefit from the fact that, if a dividend continues to be paid after a share has fallen in price, they receive a greater number of shares upon reinvestment of that income than if the share price had not fallen. The combination of income distribution and reinvestment at attractive valuations can be an effective way to accumulate capital with relatively low risk over the long term. This is why dividends offer some downside protection in bear markets - if they remain relatively stable, then they grow in size relative to the capital value of an investment. They can also accelerate returns when markets recover by leading investors to buy shares inexpensively during depressed periods in markets.
Reinvested dividends are still the main contributors to total returns, typically contributing at least 70%, and sometimes 100%, of total returns.
The level of yield, real dividend growth and multiple expansion together make up real total returns from equities. The strategy team of Société Générale has analysed real equity returns since 1970, breaking down 40 years of data into those three constituents – dividend yield, dividend growth and multiple expansion (see chart below).
Dividend yield and real dividend growth are key to real total equity returns
Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and can fall as well as rise due to stock market and currency movements. When you sell your investment you may get back less than you originally invested. Current yields are not indicative of future yields.
A focus upon companies tending to pay a regular cash dividend may lead to a portfolio comprised of companies that are reasonably valued and generate cash flow in a sustainable manner. Such companies tend to be sensibly managed and financed and allocate shareholders’ funds with a view to long-term returns on capital.
Our view is that a dividend is much more than merely a component of the overall return from a stock. It is tangible evidence of a firm’s profitability and represents a commitment by the management of a company to return the cash flow it generates to shareholders on a regular basis. In addition, the regular payment helps align the interests of a company’s management with those of its shareholders, especially when management compensation is
linked to shareholder returns rather than stock options (share options) that do
not give holders a right to a dividend.
A commitment to paying dividends makes it less likely a company will allow cash to remain idle on its balance sheet or divert it to potentially risky ventures, such as a merger or an acquisition. In addition, that commitment reduces the possibility of management burdening a business with too much debt.
Some investors fear adhering to an income-focused strategy is likely to lead to businesses with low growth potential based on the assertion that paying a dividend reflects a company’s lack of other investment opportunities or ideas and this will lead to poor returns. This belief is flawed as studies show there is a positive correlation between a company’s pay-out ratio and subsequent earnings growth. Furthermore, the return from a share is not simply how quickly a company grows its earnings for a given amount of capital employed but rather how quickly a company can do so in relation to expectations. It is our view some investors have a tendency to overpay for growth companies and to underestimate the capital required to finance a company’s growth, thereby running the risk of diminishing their long-term returns. In that context, I believe an income bias may shield long- term investors from this particular risk.
Dividend proliferation
The proliferation of dividends is a global trend. My experience is that increasingly companies consider and are prepared to discuss their distribution policy regardless of where they are listed. In addition, there is a growing realisation on behalf of management teams that investors reward a clear dividend policy. A feature of emerging market companies is that they often still have substantial family share ownership. Having weathered events such as the crisis in Asia in the late 1990s, many families believe the payment of a regular dividend is an effective way of allowing such family members to use that cash to diversify their holdings. There may have been concerns dividends in emerging markets – being a relatively new phenomenon – would be suspended when more difficult times came. However, recent events have shown this not to be the case.
Companies seek to maintain a dividend once it is established in order to avoid the negative signal to the market that can result when it is reduced or stopped. Research by Morgan Stanley Capital International and Citibank has examined the resilience of dividends
in periods of global earnings downturns. Focusing on periods of earnings downturns from 1970 to October 2008, the research found corporate earnings on average fell
by 25% while dividends rose on average by 2.4%.\* Of course, a notable exception to this occurred during the financial crisis of 2008/2009 when financial institutions that received government aid were required to slash dividends. on the whole companies that continue to pay dividends in down markets have the potential to outperform, as investors may attach greater importance to the stability of a dividend policy in a downturn.
more to consider than dividend yield alone
The major themes we have identified plus strong fundamentals form the basis for holding any stock. By allying that yield discipline to a robust global thematic investment process we can seek to generate attractive returns for investors.
It also encourages a contrarian approach (i.e., buying companies that have fallen out of favour) and discourages a too close attachment to the stocks held (ideally stocks are sold once the share price has appreciated in value) and ensures that each company held generates a yield in its own right.
In my view, dividends tend to be less volatile than the economy and the market, allowing investors potentially to turn the inherent volatility of equities to their advantage.
