Many investors, especially those that use a cash flow approach to investing, focus on companies that pay relatively high dividends. The focus on high dividend payers leads to a value strategy. The question for investors: Is that a good value strategy?
To find the answer, we'll look at the evidence on the performance of several of the largest domestic mutual funds/ETFs that focus on dividends. To see how this focus impacts returns, we'll use the data from Morningstar to compare the performance of the dividend-oriented funds to the large and small value funds of Dimensional Fund Advisors (DFA), which don't use dividends to determine which stocks to include in their portfolios. (Full disclosure: My firm Buckingham recommends Dimensional funds in constructing client portfolios.)
The table below shows the returns for the 5-year and 10-year periods ending January 24, 2013.
|Fund||Morningstar Category||5-Year Annualized Return (%)||10-Year Annualized Return (%)||Assets Under Management|
|IShares Dow Jones Select Dividend Index (DVY)||MV||18.6||6.7||$12.5B|
|SPDR S&P Dividend ETF (SDY)||LV||18.6||n/a||$12.1B|
|WisdomTree SmallCap Dividend (DES)||SV||21.6||n/a||$1.0B|
|WisdomTree LargeCap Dividend (DLN)||LV||18.3||n/a||$1.7B|
|WisdomTree Total Dividend (DTD)||LV||19.0||n/a||$0.4B|
|DFA Large Cap Value (DFLVX)||LV||23.0||8.0||$12.4B|
|DFA Small Cap Value (DFSVX)||SV||26.0||9.0||$10.0B|
LV=Large Cap Value MV = Mid Cap Value SV= Small Cap Value
The three large value funds that were dividend oriented underperformed DFLVX by from 4.0 percent to as much as 4.7 percent over the 5-year period. The average return of the three was 18.6 percent, underperforming DFLVX by 4.4 percent. Since DVY is a mid-cap value fund, we'll compare its performance to that of the average of the returns of the DFA Large Cap Value and Small Cap Value funds. DVY underperformed by 5.9 percent a year over the five-year period and by 2.3 percent a year over the 10-year period. DES, the one small value fund, underperformed DFSVX by 4.4 percent a year over the five-year period. While the evidence is for just five years, with one exception of a 10-year period, it's entirely consistent with the historical evidence that dividend strategies are a poor value strategy - of all the value metrics (price-to-book, price-to-cash flow, price-to-earnings, price-to-sales), price-to-dividends produces the smallest value premium. The table below shows the returns to the various value metrics for the period July 1951-December 2012 (data for the longest period available).
Annualized Return (%)
High Dividend to Price
High Book Market to Price
High Earnings to Price
High Cash Flow to Price
Total Stock Market
Data based on Fama-French Indices
It's also worth reviewing the findings of the 2012 paper by Wesley Gray and Jack Vogel, authors of the 2012 paper "Dissecting Shareholder Yield." They add to the research on this subject by examining different yield metrics. Gray and Vogel examined four metrics to see if they had predictive value:
- Dividends - DIV
- Dividends plus repurchases - PAY1
- Dividends plus net repurchases (repurchases minus equity issuance) - PAY2
- Dividends plus net repurchases plus net debt paydown - SH/YD
The data covers the period 1971-2011 and the largest 2,000 stocks. The following is a summary of their findings:
- Controlling for exposures to the market, size, value, and momentum factors, DIV and PAY1 strategies have no alpha (excess return) after controlling for either the 3- or 4-factor models - they don't generate statistically reliable excess risk-adjusted returns.
- Regardless of the yield metric chosen, the predictive power of separating stocks into high and low yield portfolios has lost considerable power in the last 20 years. In the latter half of the sample, from 1992 through 2011, DIV loses any forecasting ability it might have had in the previous time period.
- Splitting a yield category by payout percentage doesn't improve risk-adjusted performance - firms with higher payout ratios don't earn higher risk-adjusted returns.
The authors concluded: "Our evidence corroborates what previous authors have concluded: dividend yield is no longer an effective metric to predict future returns." Thus, if you are using dividends to determine your holdings, or the funds you use are, the question you should be asking yourself is: Why am I ignoring the evidence?