What's Risen Faster Than Inflation? Dividends
Summary
- A one-two punch threatening income investors: rising inflation and low interest rates.
- Dividends have historically grown faster than inflation and can help investors outpace inflation.
- ETFs focused on dividend-growth stocks can help income-seeking investors diversify sources of income and seek long-term returns.
By Daniel Prince, CFA, and Robert Hum, CAIA
The first Big Mac cost 45 cents. Today, the classic burger with special sauce costs nearly $6.1
The long-term effects of inflation erode how far you can stretch a dollar, and not just at the drive-thru. For income investors, fast-rising inflation tends to shrink the buying power of bond interest payments, an especially vexing challenge given that interest rates are currently near historic lows.
Bonds, of course, play an essential role for investors, but ETFs targeting stocks that are poised to grow their dividends can help diversify income and enhance returns over the long term.
Super size me
U.S. Big Mac prices
Source: The Economist (as of Jan. 12, 2021)
Dividends outpace inflation
We get lots of questions from clients about how to reinvigorate income using high-dividend-paying stocks. Many don’t realize that when inflation is rising quickly, dividends have a key advantage compared with bond coupons: potential for growth. Over the past 150 years, dividends paid by U.S. companies have grown 3.7% per year compared with 2% per year for inflation.2
Doubling up
Annualized dividend growth of U.S. stocks vs. inflation, 1871-2021
Source: Shiller Data Library. Data covers the period January 1871 to March 2021. Dividend growth based on the S&P Composite. Inflation based on CPI.
Over four decades, shares of companies that initiate and grow dividends have outperformed shares of companies that kept dividends the same or paid no dividends. Importantly, dividend growth stocks have been less sensitive to rising rates compared with bonds - a key consideration with U.S. policy interest rates near zero.3
The dividend growth advantage
Dividend growers and initiators have led non-dividend payers and those with no change to dividends.
Source: BlackRock. Data from 1/1/1980 through 12/31/2020. The investment universe is the 500 largest U.S. stocks by market cap during each respective month. Dividend policy constituents are calculated on a rolling 12-month basis and are rebalanced monthly. Category cumulative total returns are calculated on a monthly basis and include dividends. Shown for illustrative purposes only and does not represent the performance of a specific investment product. Past performance is not indicative of future returns. The “Dividend growers & initiators” category represents performance for companies which either increased or initiated their dividend distribution. The “No change to dividends” category represents performance for companies which paid a dividend but have not increased nor decreased their dividend distribution. The “Non-dividend payers” category represents performance for companies which did not pay a dividend.
Secret ingredient: Consistency
Companies with resources to grow dividends consistently tend to be profitable, financially sound and well-known. For example, Microsoft (MSFT) has grown its annual dividend for more than 10 consecutive years, with its latest payment representing 10% dividend growth year over year. Among international stocks, food and drink conglomerate Nestle (OTCPK:NSRGY) has raised its dividend for 25 years in a row.4
The iShares Core Dividend Growth ETF (DGRO) and its counterpart, the iShares International Dividend Growth ETF (IGRO), seek to track indexes that include companies that have grown their dividends for five consecutive years or more, in addition to other criteria. Both ETFs track indexes that seek out companies that appear likely to continue growing dividends in the future, and both exclude non-dividend paying stocks.
Companies with lengthy dividend growth records tend to be concentrated in mature industries, and increasingly include corners of information technology. In fact, tech sector companies have been steadily increasing dividends for at least five years and recently made up 20% of DGRO’s holdings.5 As sectors such as tech continue to mature, dividend growth strategies are increasingly diversified and contain stocks with both “growth” and “value” characteristics.6
Summing it up
The prospect of higher inflation at a time when interest rates are historically low make this a challenging market for income investors. iShares dividend growth stock ETFs can help thread the needle between generating income and growth that can potentially outrun inflation.
1 Source: The Big Mac first debuted at a Uniontown, Pa., restaurant in 1967, according to McDonald's biography of Big Mac inventor Jim Delligatti); The Economist "Big Mac index," the cost of U.S. Big Macs was $5.66, as of Jan. 12, 2021.
2 Shiller Data Library, http://www.econ.yale.edu/~shiller/data.htm. Data covers the period January 1871 to March 2021. Dividend growth based on the S&P Composite. Inflation based on CPI.
3 Federal Reserve Bank of St. Louis, BlackRock. From July 2014 - May 2021, the iShares Core Dividend Growth ETF (DGRO) and the iShares Core U.S. Aggregate Bond ETF (AGG) show a .26 and -.59 correlation with changes in the 10-year government bond yield respectively
4 Any companies mentioned do not necessarily represent current or future holdings of any BlackRock products. The following funds mentioned in this document have a percentage holding of Microsoft Corp: (DGRO: 3.18%, IGRO: 0%), McDonald's Corp (DGRO: 1.22%, IGRO: 0%), and Nestle SA : (DGRO: 0%, IGRO: 3.04%). As of 6/28/2021. Subject to change.
5 BlackRock as of 6/11/2021. Holdings subject to change. Because DGRO's methodology requires 5 years of consecutive dividend per share growth, its technology weight represents historical dividend growth in its universe of US equities.
6 Morningstar as of 5/31/2021. DGRO holds 41.5% and 8.5% in value and growth. IGRO holds 21.1% and 10.8% in value and growth.
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