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Why all the fuss about dividends?

Posted by admin on December 1, 2008 in Dividends

If you are a regular reader of financial blogs, you probably noticed an inordinate amount of attention paid to dividend investing.  Beyond their obvious appeal as cash flow based investments, what is all the fuss about? After all, aren’t dividend stocks mainly composed of boring and mature companies with minimum upside potential? While dividends do constitute the majority of stock return over time, the knock on dividends has been that returning money to shareholders is not the optimal use of profits. The super growth companies are not dividend payers. For true gains, one should invest in growth companies right?

The numbers prove otherwise. Morningstar has created two dividend related indexes: the dividend composite index and the dividend leader index. The leader index tracks the highest yielding stocks and composite is an index of all dividend paying stocks who have paid and raised dividends over time. Both are weighed in proportion to the tool pool of dividends paid. In other words, a stock paying $1.00 of dividend per share has the same weighting as another paying regardless of market cap.

Here are the respective 1, 5 and 10 year annualized performances over time of the dividend indexes in relation to the Morningstar U.S. Index, Morningstar Large Growth Index, Small Growth Index and U.S. Value Index (first # is the 1 year trailing return, 2nd is 5 year and 3rd is 10 year).

1. Dividend Composite Index(dividend yield: 4.47%): -30.72%, 2.37%, 3.21%
2. Dividend Leaders Index (dividend yield: 6.87%): -33.14, 1.4%, 5.04%
3. U.S. Market Index (dividend yield: 2.94%): -36.31%, 0.86%, 0.97%
4. U.S. Large Growth Index (dividend yield: 1.16%): -39.27%, -3.82%, -5.68%
5. U.S. Small Growth index (dividend yield: 0.37%): -39.81%, -0.59%, 1.84%
6. U.S. Value Index (dividend yield 5.27%): -36.31%, -5.20%, 2.97%

In other words, an index relying upon dividend yielding stocks, regardless of whether you focus on yield only or dividend growth, generally outpaces other types of investing styles over time. It is interesting to note that the value index which had the 3rd largest return over the 10 year period relies heavily on a strong dividend yield as well. Thus, dividend stocks tend to produce both cash flow and appreciation and/or downside mitigation.

I can’t speak for comparing U.S. dividend stocks with international stocks. It is a bit of an apples and oranges comparison. Here is a summary of all of Morningstar’s stock indexes for your own informational purposes.