A long-term study found that share price gains accounted for about a third of most investors’ stock returns. Reinvested dividends made the other two-thirds of the returns.
A study found that reinvested dividends generated two-thirds of the total returns for American investors over 114 years. Share price gains accounted for the other third.
Since the most recent stock market bottom in March, 2020, stocks have roared back. Stock market indices have routinely reached new record highs. Many stock investors have earned large share price gains. But at some point, the market will stumble again. The fact is, share price gains are fickle.
Secure dividends, by contrast, last, regardless of changes in share prices. A study shows that dividends are more important than share price gains. This study was done by professors Elroy Dimson, Paul Marsh and Mike Staunton of the London Business School.
Dividends—two-thirds of the returns
The professors looked at the total returns on US stocks from 1900 to 2014. They found that share price gains provided only a third of the returns. Meanwhile, reinvested dividends generated two-thirds of the returns. So dividends are more critical to the success of many investors. Particularly long-term investors, whose money continues to compound.
We’ve always considered dividends in building and maintaining our list of Key stocks. Most of our Key stocks have strong long-term dividend records. One exception is CGI Inc., which reinvests all of its earnings into its businesses.
Other Key stocks began paying dividends after we added them to our list of Key stocks. This includes Open Text Corp. and engineering and infrastructure company Stantec Inc.
At the beginning of each month, except for January, we publish our Investment Planning Guide. It includes best buys for income. It also includes an example of an income portfolio. In the first issue of each month, we list Key stocks that have raised their dividends over the previous month. Rarely does a month go by without a dividend increase by at least one of our Key stocks.
When Canadian companies raise their dividends for at least five years in a row, they become ‘dividend aristocrats’. Such stocks provide useful benefits. Dividends usually climb faster than inflation. This enables retirees to keep up with the rising cost of living. Even though inflation is much lower than it was in the 1970s and 1980s, prices still inexorably rise. Some retirees can live off their increasing dividends while preserving their capital. This can ease the common worry about outliving one’s savings.
Remember, too, that rising dividends make it far more likely that you’ll profit from share price gains. That’s because a rising dividend boosts a stock’s yield—if the price stays the same. Eventually, that yield becomes too juicy to ignore. Income-seeking investors will bid up the share price. But whether you profit from an increasingly generous yield or share price gains or both, you win.
Just remember two things. First, exceptionally high dividend yields can signal danger. Often dividend yields peak just before a dividend cut. So we prefer reasonable dividends that rise each year. If the company stops raising its dividend, that can be an early-warning signal. This happened with BCE Inc. and Loblaw Companies a number of years ago.
Focus on financial and utility stocks
A second thing to keep in mind is that the sustainability of dividends depends partly on the economic sectors the companies operate in. The two most stable are the Financial and Utility sectors. They typically raise their dividends when they’re confident that they can continue to pay them.
The two least stable sectors are Resources and Manufacturing. When commodity prices plummet, many producers reduce or eliminate their dividends to conserve cash. Suncor Energy reduced its dividend last year. CAE Inc. saw the need to train commercial pilots fall off a cliff. So while they may pay high dividends in good times, they’re liable to cut them in downturns.
Consumer stocks are in between. In order to ensure the continuity of your dividends, it’s best to focus on companies that provide consumer staples. Suppliers of luxury goods and services, by contrast, can see their sales drop in difficult times.
This is an edited version of an article that was originally published for subscribers in the July 23, 2021, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
The Investment Reporter, MPL Communications Inc.
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