Heartland white paper examines dividend-paying stock track record

Milwaukee-based Heartland Advisors Inc. recently won an award from the Mutual Fund Education Alliance for its white paper, “Dividends: A Review of Historical Returns.”

The national award recognized Heartland for a “timely and “well-researched” white paper in the best educational material category. The firm also won an MFEA award for best introductory kit materials for its Heartland International Small Cap Fund.

In the white paper, Heartland examines the historical performance of dividend-paying stocks during different types of markets.

Dividends have generally provided a greater long-term return than non-dividend stocks, it said.

“For example, one study examines the components of total equity returns of U.S. stocks from 1802 to 2002,” it said. “Over the 200-year period, dividends (plus real growth in dividends) accounted for fully 5.8 percent of the 7.9 percent total annualized return.”

Historically, during moderate to severe market corrections, dividend-paying stocks have outperformed non-payers, the paper explained. However, during sharp market recoveries, dividend-payers have underperformed.

The paper discussed the hypothetical growth of $1 invested in 1928 if dividends paid were reinvested. By December 2010, all five quintiles of dividend-payers would have surpassed the non-paying stock.

“(However), many investors have an investment horizon shorter than 83 years. Furthermore, within the past 83 years, markets have gone through several boom-bust cycles. No doubt, the timing of investment can be critical to an investor’s ultimate fortunes,” the paper said.

In Heartland’s analysis of several 20-year investment horizons, the same result holds to be true—dividend paying stocks outperform non-payers. In addition, dividend-payers are less volatile over time.

“Nonetheless, any given 20-year holding period can contain several frightening market events that can jar an investor’s confidence. The past 20 years has been no exception,” it said.

The white paper also analyzed dividend paying stocks during market corrections of 10 percent or greater, and found that while dividend-payers had the greatest advantage over non-payers during a moderate correction, there was still an advantage to dividends during severe downturns.

However, Heartland cautioned investors that it’s difficult to change a portfolio quickly to counteract a short drawdown.

“As such, a strong case can be made for maintaining a strategic allocation to dividend paying stocks, if only on the grounds of risk control,” it said.

An advantage of dividend paying stocks in down markets is the ability to invest at a lower cost through a regular dividend payment investment strategy.

There are instances when non-payers outperform paying stocks, such as during sharp market recovery, the paper said. Included research shows 24 periods from 1928 to 2010 where non-payers had an advantage over dividend paying stocks immediately following a downturn.

While it would seem dividend payers with high yields are the best investment strategy, Heartland explained the data set shows that a lower quintile is actually more profitable over time.

“In the full 83 year sample, quintile four outperformed quintile five, and did so with lower volatility,” it said.

This phenomenon could be the result of unsustainably high yields in quintile five, or yield traps. When a high dividend paying stock drops sharply, dividends are driven down by expected lower earnings.

“It stands to reason that many companies with unsustainably high yields will, eventually, end up in the highest yielding portfolios before making a dividend cut or declaring bankruptcy, thus hampering returns and increasing volatility within the highest yielding portfolios,” the paper said.

Concentration risks and insufficient research may also contribute to a poor performance in quintile five dividend returns, it concluded.

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