Dividend Payers Outperform Non-Payers. But What About Too Much Of A Good Thing?

by: Left Banker


In this article, I discuss a study on the overall performance of dividend-paying stocks vs. non-dividend payers.

The report also considers relative performances of five cohorts of dividend payers based on yield.

Results confirm the enhanced performance of dividend payers over non-payers and reveal interesting relationships for performance and volatility among dividend-paying stocks.

There are few topics on Seeking Alpha that generate as much debate as the importance of dividends to an investor's returns. I ran across a review from Heartland Funds that provides observations that should be relevant to these discussions and of genuine interest to the dividend-focused investor.

The paper uses a large data set on U.S. securities from Kenneth French and the Center for Research in Security Prices at the University of Chicago. This data set includes all equity securities listed on NYSE, AMEX, NASDAQ and NYSE Arca during the time periods covered. The anonymous author(s) constructed five portfolios of dividend-paying stocks based on quintiles of dividend yield, with quintile 5 representing the highest yielders. Portfolios were restructured annually.

A result of primary interest is that over the entire record, spanning the 84-year period from 1928 to 2012, dividend payers outperformed non-dividend payers by a substantial margin. The worst-performing quintile of dividend-payers beat non-payers by a factor of 1.84. The best-performing quintile outperformed non-payers by an astonishing 7.31 times.

Over the long-term quintile 4, the second highest-yielding group, outperformed the other 5 portfolios. This was followed in order by quintiles 5 (highest payers), 2, 1 and 3. The study's authors report average annual total return, annualized standard deviation, and Sharpe Ratios for the portfolios as follows:

Obviously, 84 years exceeds the typical investor's horizon. The authors considered this and looked at their data in a different way: as 67 periods of 20 consecutive years. Once again, quintile 4 takes the gold and the non-payers trail the field.

Of particular interest is the finding that quintile 4 had the lowest drawdowns in down markets. The data in this table show the average drawdowns of the stocks comprising each cohort during periods of broad market drawdowns of greater than 30% and in 5% increments through the 10% standard for a market correction.

Although the non-payers suffered the worst losses in market downturns across the board, they also experienced more substantial recovery in the six-month periods following the market bottoms.

There is also some interesting graphical analysis on the distribution of returns and volatility on a year-by-year basis that I'll not reproduce here. The interested reader should examine these directly from the report. One take-home message from these presentations is that over the past 20 years, the dividend payers, especially quintiles 3 and 4, consistently scored the lowest volatilities.

It's easy to overinterpret these results, particularly with regard to the non-dividend payers which cohort surely includes a high fraction of fairly low-quality stocks that skew the results. There is no effort to control for this. But the distribution of returns by quintile of dividend yield is certainly an interesting result and one worth pondering.

One take-away could be that the highest yielding stocks may not necessarily be the best performers. While the data support this, it's not an overwhelming effect as the quintile 5 cohort tends to follow closely quintile 4 for most metrics. One exception is its somewhat lesser ability to withstand the worst market corrections and crashes. In addition, this group does achieve its performance with higher volatilities than some of the lesser-yielding quintiles. Overall, the least volatile group was quintile 2 followed closely by quintile 3 in both the full 84 year analysis and for the 20 year periods.

This is not, by any means, a definitive study, and it would probably not sustain a rigorous academic review. It does, however, highlight the outperformance of dividend-paying stocks over time. At the same time, it suggests that caution in reaching for the highest-yielding dividend payers should be rewarded.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.