Why Dividends? A Review Of The Literature

by: Accelerating Dividends

I have been exploring dividend investing for about six months now. I have read about it on websites and blogs that are dedicated to it as well as read articles published here on Seeking Alpha over the last several months. I have felt inspired by this literature and the enthusiasm of those who have successfully lived by it and are reaping the benefits of their diligence. I wanted to explore more fully how dividends may benefit me and how they play a larger role in a portfolio that is either focused solely on them or includes them to any extent. I desired to explore the academic literature on this subject however I found that I could not access most of the articles I desired. Therefore I resolved to explore the literature from the financial sector, primarily asset management groups. These groups have dedicated managers to developing dividend-specific funds and have done some research to support and justify the existence of these funds and dividends in particular.

There are a number of benefits to investing in dividend-paying stocks whether your portfolio is income generating or dividend focused. Dividends provide a yield that makes an important contribution to the generation of income for anyone's portfolio. Dividends can be used to help protect and increase wealth. Dividends alone will not make you rich. However, investing in the next Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) back in the day, and other investments like those that reached incredible highs at the right time is difficult and for some not likely to occur without having suffered losses in the process. Furthermore, there appears to be no end to the number of issues that concern the market. There is continued difficulty in Europe, evidence regarding a slowing global and domestic economic recovery, decreasing consumer sentiment, political posturing in the U.S. and other events that continue to put pressure on the market and companies. Dividends then are the one source that can continue to provide income and yield in a time where it is difficult to find or income through capital appreciation is threatened.

From my review of the literature, there are five key themes that kept recurring. These themes are presented below.

A signal of financial health

The ability for a company to pay dividends over the long term provides some evidence of the financial stability of the company. Particularly in the U.S., companies that tend to provide a dividend have ingrained this policy more completely into the company's structure and identity. These companies tend to ensure that the dividend can be maintained for the long term, tend to provide stable payouts and resist the notion to eliminate or cut the dividend. Most companies are capable of maintaining and even increasing their dividends during difficult times such as the Great Recession. Examples of companies whose financial health deteriorated due to economic conditions or changes in their market segment include General Electric (NYSE:GE) and Pitney Bowes (NYSE:PBI). Examples of companies that have continued to grow their dividends even during difficult economic conditions include McDonald's (NYSE:MCD), Johnson & Johnson (NYSE:JNJ) and Exxon Mobile (NYSE:XOM). These latter companies showed the strength of their balance sheets by continuing to increase their cash dividend.

Companies that are capable of increasing and sustaining their dividends tend to be the companies that have products and services that consumers consume regularly or renew. These companies may further have a strong brand or a "moat," which contributes to customer loyalty and repeat business. These factors often translate into increased and higher profit margins that become strong cash flows and earnings growth. With these factors in play, these companies can in turn continue to pay out a cash dividend.

Some have believed that dividends serve as a proxy to earnings growth. The idea behind this was that dividend growers (companies that raised their dividends consistently) represented the highest-quality growth companies around the world. Dividends are a signal of how the company manages its cash flow by balancing payouts to its shareholders while also reinvesting into the well-being of the business.

The old adage appeared many times: Dividends are paid out in "hard" cash from actual real earnings and they cannot be manipulated. If a company has the ability to pay a dividend over a long period of time [e.g. think Proctor & Gamble (NYSE:PG), Coca-Cola (NYSE:KO), the Colgate Palmolive Co. (NYSE:CL), which each have increased their annual dividends over the last 50 years] then the dividend can serve as a signal of financial health. What have these particular companies done? They have proven themselves as stable companies. Stable companies like these tend to grow payouts. Growing payouts are generally a sign that the company has a competitive advantage, strong balance sheet and a management team showing its confidence in the company's abilities to generate earnings and maintain strong cash flows that will continue to support future dividend payments and company growth. These companies are disciplined with regards to their financial health.

A source of total return

Dividends are a source of income. While dividends are being collected you may also be growing your capital appreciation, which is your second source of income. Given that today's global environment threatens to impact world economies and has created more volatility in the markets, dividends provide a steady income stream when capital appreciation may not be accelerating. When looking at the S&P 500, the dividend contribution to total return for the last 80 years equated to 44%. When nearly half of the total return is achieved from dividends, it suggests that dividends may have an appropriate place in a balanced portfolio.

Most people are probably familiar with the following graph produced by Ned Davis Research, which shows the S&P 500 dividend reinvested total return (yellow line) compared with the price return alone (dark blue line) from 1930 to 2010. The graph clearly shows the contribution that reinvested dividends make to total return. In fact, the contribution of reinvested dividends equates to an annualized total return of 9.4% compared with 5.2% if reinvested dividends were removed.

S&P 500 Dividend vs. Price Return

The graph below was published by Indexology and compares the Price Return (DJI) vs. the Total Return (DJITR) for the Dow Jones Industrial Average from September 30, 1987, to March 30, 2012. The conclusion is the same as was seen for the S&P 500 in that reinvested dividends make a considerable contribution to total return.

Dow Jones Total vs. Price Return

Here is another example of the effect of dividends on total return. The graph below courtesy of Simplestockinvesting.com shows what happened to 1$ invested in 1950 in the S&P 500 Total Return Index when all dividends were reinvested versus the S&P 500 price only. When dividends were received and then subsequently reinvested, the difference resulted in a return that was eight times higher than price only.

S&P 500 Growth of $1

One of the important things to note is the long-term time frame in which these returns occur. In today's market environment a stock is generally held for less than a year. If an investor held on to a dividend stock for that time period, he or she may very well be disappointed in the total return. Dividend investing over the long term allows the growth seen in the graph above to occur. Day trading and short-term trading will not allow the benefits of dividends to take root. This is why dividend investing has the "buy-and-hold" mentality. From Guinness Atkinson Funds, we can read the following:

For an average holding period of 1 year, dividends accounted for 27% of total returns for the S&P 500 since 1940. If we increase the holding period to 3 years, dividends account for 38%, 5 years it increases to 42%, over a 10 year period it rises to 48%, and with a 20 year holding period dividends account for some 60% of total returns

Dividends do make a considerable contribution to total return, if one is patient enough to allow the dividends to work for them to generate these returns. That being said, several of these literature pieces emphasized that the contributions made by dividends were greater during lower or slower growth periods. During the 1990s, dividends made less of a contribution to total return than price appreciation, however during the 1940s and 1970s, dividends made up well over half of the contributions in total returns in those decades where bear markets were dominant.

Relatively lower volatility

Beta is a measure of stock volatility in relation to the market. The market is considered the S&P 500 and is assigned a value of 1. If a stock moves less than the market it has a beta less than 1 and vice versa. High beta stocks are considered "riskier" or have higher price fluctuations and volatility but may also provide higher returns leading to some investments that could "beat the market."

Dividend stocks have varying betas. Using Finviz.com stock screener, I extracted all stocks being traded in the U.S. and removed the ETFs and other fund type investments. I then separated the dividend paying versus non-dividend paying stocks and averaged the beta for each group. There were several stocks in each group that did not have a published beta and had a negative beta. Those with negative betas were classed under those with no betas as this would skew the data. As a result, this led to an average beta of 1.103 for dividend-paying stock and 1.404 for non-dividend paying stocks.

According to David Fish's Champions, Contenders, and Challengers spreadsheets, the dividend champions (over 25 years of dividend increases) have an average beta of 0.84, the contenders (10-24 years of dividend increases) have an average beta of 0.79, and the challengers (5-9 years of dividend increases) have an average beta of 0.91. All three combined average 0.79. Some well-known companies and dividend-paying stocks with low betas include General Mills (NYSE:GIS) at 0.17, Kimberly-Clark Corp. (NYSE:KMB) at 0.32, Wal-Mart Stores Inc. (NYSE:WMT) at 0.34, and Verizon Communications (NYSE:VZ) at 0.46.

According to a study by Ned Davis Research, investors who invested in dividend-paying companies could have achieved equal if not superior returns over the long term with lower volatility. Based on the S&P 500, companies that are considered dividend growers (companies that growth their dividend consistently) returned 10.3% over 30 years, which ended December 31, 2011. The volatility experienced over that time was 15.9%. The companies that are considered non-dividend payers returned 1.6% over the 30-year period with a volatility of 24.4%.

The figure below contains data from Robert J. Shiller's book "Irrational Exuberance" and was compiled into a graph by Guinness Atkinson Asset Management. This figure shows an interesting point regarding dividend volatility compared to earnings volatility. The figure represents the S&P 500 dividends per share and earnings per share growth on a year-by-year basis. This graph shows that dividends are less volatile than earnings, which provide a level of comfort for investors during recessionary periods. For long-term investors, this apparent weakness allows them to take advantage of low stock prices.

Dividends vs. Earnings Volatility

Higher returns despite changes to interest rates and inflation

Many comments have emerged recently in articles on Seeking Alpha and elsewhere regarding how dividend investing will be impacted once interest rates begin to increase. It could even be said that dividend investing has increasingly become popular once again due to the low interest rate environment. Some suggest that an increase in interest rates will affect equity performance.

The graph below from Ned Davis Research (additional information about the graph is found in point 1 at the end of this article) shows the returns for dividend-growing companies (blue line), dividend-paying companies (orange line) and non-paying dividend companies (tan line) following a Federal Reserve interest rate increase. These companies are listed on the S&P 500. The time frame is from January 1, 1972, to December 31, 2012. Despite what may be said regarding the perceived impact interest rates will have on dividends, the graph shows that dividend growing and paying companies continue to provide greater returns over the long term compared to non-dividend paying companies even when interest rates rise.

Difference in Dividend Types

The following graph obtained from RidgeWorth Investments (additional information about the graph is found in point 2 at the end of this article) and produced by Ned Davis Research shows the gains made between dividend-paying companies vs. non-dividend-paying companies from the S&P 500 in changing interest rate environments from January 31, 1972 to January 28, 2011. RidgeWorth's conclusions are that:

regardless of how the Federal Reserve alters monetary policy, dividend-paying stocks have historically outpaced their non-paying counterparts. For instance, when the Fed tightened monetary policy dividend-paying stocks gained 2.2% vs. 1.8% for non-paying stocks. During periods when monetary policy was neutral or easing, the gain for dividend-paying stocks was even more significant, yielding 12.3% vs. 6.2% in neutral environments and 10.0% vs. -2.5% in easing monetary environments, respectively.

Dividends and Interest Rate Changes

Inflation obviously has the effect of reducing buying power. The value of 1$ in 1950 is worth much less in today's monetary value due to the effect of inflation. As money sits in a bank account, if the interest rate is less than the inflation rate then you are in fact losing money or purchasing power. How does inflation affect dividend returns and price returns? According to the following graph from Simplestockinvesting.com, it does influence the dividend and price returns. During the 1970s and early 1980s when inflation reached over double digits or high single digits, we can see that both dividend and price returns decreased. When inflation is lower, both dividend and price returns were high. However, over time, reinvested dividend returns have been higher than price returns alone.

Inflation Adjusted $1 Growth

Furthermore, Seeking Alpha Contributor and Dividend Growth Investor David Van Knapp showed in his article "Has dividend growth kept up with inflation?" that dividend growth had exceeded inflation 31 times out of 51 from 1960 to 2011. Furthermore, the average annual dividend growth was 5.4% compared to the average annual inflation growth of 4.1%.

Here is another example regarding how dividend-paying stocks can protect against inflation. Once again, the figure below contains data from Robert J. Shiller's book "Irrational Exuberance" and was compiled into a graph by Guinness Atkinson Asset Management. It represents the rolling 10-year average growth in S&P 500 dividends per share versus the growth of inflation. According to Guinness Atkinson Asset Management and American Funds Capital Guardian, the average growth of the S&P 500 dividends per share was 5.6% since 1947. Starting at the same time, the consumer price index, which is used to measure inflation averaged a 3.7%. The figure shows that over the long term, dividend-paying companies may provide a hedge against inflation in that the growth of the dividend per share equals or outpaces the growth of inflation.

Inflation and Dividends

Downside protection during various market cycles

Stocks that pay dividends provide a return regardless of stock market conditions and price fluctuations. In our current environment, this may explain why the demand for dividend-paying stocks has increased. Dividend payers tend to have stronger balance sheets and higher profitability than non-payers, which may act as a hedge through a period of market volatility. Furthermore, when the market drops, profit margins decline and sales and earnings slow, dividend-paying companies can rely on their balance sheets and cash reserves to maintain and grow dividends as well as maintain a positive cash flow. The following graph sums up several of the subtopics discussed in this article fairly well. The graph provided by RidgeWorth Investments, shows the growth of a $1,000 investment in S&P 500 stocks by their dividend policy.

Downside Protection with Dividends

Overall, this graph clearly shows the impact that reinvested dividends have on growing an investment. In particular, it should be noted that not just any dividend-paying company will provide solid returns, but companies that are paying a growing dividend as well as companies that were initiating dividends. Dividend growers and initiators have grown the initial investment by 4585% since March 31, 1972. This further shows the importance and influence of reinvested dividends over time. When compared to non-dividend paying stocks, the difference as of March 31, 2013, between dividend growers and initiators and non-dividend paying stocks is 3887%. This graph also shows that companies that are unable to maintain their dividend and subsequently cut or eliminate it are punished by investors and have returned -7% over this time. This highlights the importance of carefully analyzing the fundamentals for each company that investors include in their portfolios to ensure that the dividend can be grown and sustained over the long term as it will make a very big difference. Even though dividend growing and initiated stocks declined during times such as the Great Recession, overall they did not decline as much as non-dividend paying stocks and have continued to grow once a recovery has taken place. As can been seen in the graph above, the dividend payers (dark red line), dividend cutters or eliminators (light blue line), non-dividend paying stocks (light red line) and the S&P 500 Equal Weighted Total Return Index (gray line) are all still below their 2007 levels which Dividend growers and initiators (dark blue line) have surpassed their 2007 highs and all dividend paying stocks (yellow line) have recovered their losses.


This article has explored the contributions made by dividends to the market. It is evident that dividends can make a difference whether they are found within mutual funds/ETFs, dividend-oriented portfolios or other trading and investing strategies. From this review, it was found that dividends make a considerable contribution to total return in the market and individual portfolios. Dividends can act as a measure of the financial health of a company, could reduce volatility in a portfolio, act as a hedge against inflation, continue to contribute in varying inflationary environments, and can provide some downside protection. Whatever your trading strategy, it can be said that dividends have and will provide income for you in your portfolio. I welcome your thoughts, opinions and comments on the matter.


1. The date of the initial fed funds rate hike is the end of any month during which the Federal Reserve first raised the target fed funds rate following a period of stable or declining interest rates; returns are the average performance for the next 36 months for time periods beginning 01/31/1972, 09/30/1977, 09/30/1980, 09/30/1987, 02/28/1994, 07/31/1999, and 07/31/2004.

2. Until 1989, the Fed used the discount rate as its key benchmark rate, and thus increases or decreases in the discount rate reflected the Fed's monetary policy. The discount rate is the interest rate charged to commercial banks that borrow money directly from the Fed. Since 1989, the Fed has targeted the federal funds rate, which is the rate at which banks borrow short-term funds from each other. While the fed funds rate is a market rate and thus not set explicitly by the Federal Reserve, the Fed maintains a desired target rate for fed funds and through its open market operations (buying and selling government debt) it influences the fed funds rate to keep it close to its target rate. The chart's bottom clip thus also plots the Fed's target fed funds rate from the beginning of 1989 forward.


Lord Abbett. (March 25, 2013). Market View: Dividend-growers could thrive in a rising-rate environment.

Simple Stock Investing. (2009). S&P 500: Total and inflation-adjusted historical returns.

Krein, D. (2012). With or without: The impact of dividends on index performance.

RidgeWorth Investments. (2011). Dividend dynamics: Assessing the benefits of dividend-paying stocks.

RidgeWorth Investments. (2012). Dividends make a difference.

Mortimer, I. & Page, M. (2013). Why dividends matter. Guinness Atkinson Asset Management.

American Funds Capital Guardian. (2012). The 80 year old fad: Dividend investing comes back into vogue.

Sarofim, F. (2013). Reasons to consider dividend-paying stocks. BNY Mellon Dreyfus Asset Management.

Franklin Templeton Investments. (2012). The case for dividend-paying equities in today's market.

Gelhaus, S., & Beyer, K. (2012). Why equity yield and dividend growth merit a closer look. GE Asset Management.

Hoesgen, E, & Hoeshen, D. (2012). The case for dividend paying stocks. Resource World Magazine.

Shearer, R., Anderson, K., & Cassese, D. (2013). "New world" wisdom: Winning more by losing less. BlackRock.

Price, Q., Hayes, R., Leavy, C., & Watt, E.C. (2012). Means, ends and dividends: Dividend investing in a new world of lower yields and longer lives. BlackRock Investment Institute.

Disclosure: I am long MCD, JNJ, PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.