TRUESHARES

Dividends Boring?

Dividend paying stocks often carry a reputation for being the snoozers of the equity world. But is that necessarily a bad thing? In the age of click-bait, speculation dominates the headlines. And why wouldn’t it? Getting in early on the next world altering idea sounds like a good bet to most of us, especially if it’s as easy as it sounds. Unfortunately, it most certainly is not as easy as it sounds. That’s why it can be pay so handsomely when you’re right. Yet, the hard reality is that finding the one “story stock” that goes to the moon requires avoiding countless others that will likely see unhappy endings.

And here’s a pro tip: When it feels like everyone at the cocktail party is invested in a stock with a game-changing idea, stay away from pointy objects, because we just might be riding high on a price bubble. So, if you’re more inclined to skip the craps table like us, try looking for a strategy that builds long-term returns by avoiding failures and prioritizes those boring dividend paying stocks. The results may surprise you. 

Dividend Payers Outperformed the S&P 500 but There Was a Better Option

Before diving into dividend stock performance, let’s take a quick look at two ways investors might invest for dividends.

The simplest approach? Buy stocks that pay dividends.

A more refined approach? Buy stocks that pay dividends and are growing those dividends over time.

As we can see below, either of these dividend investing approaches has shown a history of outperforming the stock market over the last 20 years. However, investing with dividend “growers” not only provided better performance, but it did so with lower volatility (risk) than dividend payers and the broader market. The point about risk is likely relevant if you’re concerned about the rocket-like climb in valuations over the last year but still want to maintain equity exposure in your portfolios.

Growth of $10,000: Dividend-Paying Stocks, Dividend-Growing Stocks and S&P 500 Index

Source: Bloomberg, as of 12/31/2020. Index performance shown is for the S&P 500 Index and does not represent TrueShares fund performance. Performance is cumulative and based on quarterly returns. The Dividend Payers or Dividend Growers category constituent inclusion or exclusion is evaluated quarterly, with performance for that group calculated for the following quarter. Dividend Payers represents performance of companies who paid a dividend in the prior quarter. Dividend Growers represents performance of companies who paid a dividend in the prior quarter and grew their dividend payments over the subsequent year. It is not possible to invest directly in an index. Performance data quoted above represents past performance and does not guarantee future results.

And it’s not just about the return benefit. Dividend “growers” also provide the ability to grow an income stream over time, an important characteristic for income-oriented investors.

We also tend to think they may be less sensitive than bonds to increases in interest rates in the near-term. This belief is driven by our view that both bond and high-growth equity security valuations benefited disproportionately compared to dividend-paying stocks as interest rates fell. 

Planning Your Dividend Strategy Means Taking a Deeper Dive

Even though this is a historical look-back, an important thing to note is that the portfolio of “growers” above was constructed with a forward-looking approach; it isolated the performance of companies that grew their dividends in the subsequent year with quarterly rebalancing.

But since knowing which stocks will be part of that group in advance is impossible, how does an investor build a portfolio of dividend growers?

We believe the answer lies in:
• Identifying stocks with attractive, sustainable dividend yields for current dividend cash flow, and
• Pursuing dividend growth, which is the result of a company’s payout ratio, free cash flow stability/growth and management/board’s desire to grow dividends.

As a result, investing for dividend growth requires fundamental analysis to identify which stocks are most likely to grow and/or sustain their dividends going forward.

If the challenge of building a forward-looking dividend portfolio seems daunting, looking at managed products like ETFs may start to make sense. 

Takeaway: Focus on Companies with Attractive Current Yields and Prospects for Dividend Growth

At TrueShares, we believe the “secret sauce” is finding companies that provide high current dividend yields with prospects for above average dividend growth.

As explored above, to execute this strategy, we believe you need to focus on companies with the potential to deliver:
• Attractive relative performance
• Lower volatility than the market
• Attractive income today
• Growing income over time

Finding companies that check all these boxes requires diligent, forward-looking research.

You should be afraid of gambling on money-losing stocks. It will most certainly end badly for many. But instead of completely avoiding the market, why not turn to something that has proven to work over time? As an active manager, it’s no surprise that TrueShares believes that staying the course with a forward-looking dividend investing strategy is an attractive option for many investors!

Important reminder: Stocks that pay high dividends or continue to grow dividends can fall out of favor with the market causing such securities to underperform companies that do not pay high dividends. Likewise, there can be no assurance that companies that have historically paid a dividend will continue to do so or may reduce dividends.