Introduction

In recent years, dividends’ contribution to total return has been one of the most heavily-studied topics in the investment world.  Several conclusions about the contribution that dividends make to total return have been claimed.  However, these conclusions vary greatly.  I have seen studies claiming that 90% of returns are attributed to dividends, several claiming 50% or more, and others arguing for a 30% contribution.  Ironically, they all seem to be correct depending on the data-sets and/or timeframes being measured.

Nevertheless, I am on record of not being a fan of the typical academic study applied to finance.  I have several problems with conclusions drawn from studies, but my major issue is with what I consider the over-generalized nature of how they are conducted.  Consequently, I believe that although their conclusions may be valid based on the data as presented, I also believe they can be very misleading.

Here are but a few examples of conclusions that I contend can mislead investors.  On December 6, 2010 the heads of Black Rock’s global equity team suggested that 90% of US equity returns over the last century have been delivered by dividends and dividend growth.  A prominent money-management firm reported that according to Standard & Poor’s, the portion of total return attributable to dividends has ranged from a high of 53% during the 1940s, to a low of 14% during the 1990s.  Standard & Poor’s themselves suggest that more than a third of the long-term total return of the S&P 500 can be attributed to dividends.  And I have read other studies that conclude that dividend paying stocks dramatically outperform stocks that pay no dividends.

Now remember, the above are just a few samplings.  In truth, there are numerous other studies that have presented varying conclusions about dividends’ contribution to total returns.  As a result, I commonly come across investors quoting conclusions about dividends from studies or holding what I consider misguided opinions about dividends, dividend paying stocks and non-dividend paying stocks.  Therefore, my objective with this article is to provide a more rational examination of the contributions, or their lack thereof, that dividends actually generate.

My primary position is that the contributions that dividends make vary greatly from one company to the next.  This is aligned with my general position that it is a market of stocks and not a stock market.  Therefore, rather than basing decisions on overly-generalized conclusions about the merits of dividend paying stocks over non-dividend paying stocks, I prefer a more individualized approach.

In other words, there are certain stocks where dividends matter a great deal, and there are certain stocks where dividends are completely irrelevant.  My point being, that trying to associate dividends with returns is, in my opinion and experience, a flawed approach.  Instead, I favor analyzing and evaluating the contributions that dividends have made to total return on a specific case-by-case basis.

At this point, I want it to be clear that I am not either for or against dividends in the general sense.  If income is your primary investment objective, then obviously dividend paying stocks make a great deal of sense.  Moreover, if highest total return is your objective, then growth stocks might be your best choice.  But most importantly, I intend to demonstrate that total return is not a function of whether a company pays a dividend or not.  There are many factors that drive total return, and dividends are only one of them.

Debunking the Dividend Paying Stocks Produces Higher Total Returns Myth and Vice-Versa

As I suggested in the introduction, dividends’ contribution to total return has been one of the most widely-studied topics in finance.  When conducting research for this article, I reviewed several studies on dividends.  However, for the purposes of this article, I am going to utilize a study (white paper) titled Why Dividends Matter produced by Dr. Ian Mortimer and Matthew Page, CFA fund co-managers of Guinness Atkinson Funds.

Like most studies and white papers I’ve reviewed, I felt this presentation was very well done and I thought it made some excellent and important points about investing in dividend stocks.  Moreover, I believe that their data as presented was accurate, and therefore, the conclusions drawn also accurate as presented.  However, I believe the results, although accurate, are too general in nature to support absolute conclusions regarding dividend paying stocks versus non-dividend paying stocks.

Nevertheless, for those investors that favor or follow investing in dividend paying stocks, this white paper will support their investment philosophy and beliefs.  Personally, I felt this work covers many of the important salient points supporting investing in dividend paying stocks in the general sense.  Therefore, I would wholeheartedly support much of what is written in this white paper.

My only problem is with the over-generalized insinuation that dividend paying stocks are superior to non-dividend paying stocks.  In truth, with certain individual stocks that can be true, but I argue that it cannot, and should not be considered a universal principle.  The truth is that some dividend paying stocks are superior to non-dividend paying stocks and some non-dividend paying stocks are superior to dividend paying stocks.  The only true conclusion that I believe can be drawn is that it depends on the business characteristics of each individual company.

To illustrate my point, I will provide excerpts from the above document followed by examples of some companies via FAST Graphs that support and some that refute the conclusions drawn.  My first excerpt includes the introduction to the article, followed by some general conclusions and a supporting graphic of dividends’ contribution to the S&P 500.  It is this kind of evidence that erroneously leads many investors into believing that dividend paying stocks perform better and account for higher total returns.  And frankly, on the surface, the arguments appear compelling.

“Why Dividends Matter

Introduction

Investors seem to be rediscovering the power of dividends as an important element in the pursuit of long-term total returns. Following the financial crisis of 2008/9 and the resultant fall out, traditional sources of income such as government and corporate bonds and cash, lost their luster. In this paper we aim to show that, for the long-term investor, the power of dividends from equity investing has never been diminished and has in fact been slowly and surely working away, behind the scenes, adding not just appreciation in the form of total returns but can mitigate the effects of both market falls and inflation. PROFITS ARE A MATTER OF OPINION, DIVIDENDS ARE A MATTER OF FACT Dividends are paid from real earnings and in ‘hard’ dollars – they cannot be manipulated by creative accounting. A dollar paid out to the investor is just that.

“Figure 3 below shows how the importance of dividends to total returns increases with time horizon. For an average holding period of 1 year, dividends accounted for 27% of total returns for the S&P500 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. It is important to note, too, that here we are just looking at the S&P500 as a whole and not focusing purely on companies that actually pay

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