By: Ned Piplovic,
Dividend Aristocrats are companies from the S&P 500 Index that have boosted their annual dividend distributions for at least the past 25 consecutive years and meet certain additional requirements regarding market capitalization, liquidity and trading volume.
The Dividend Aristocrats concept seems simple enough. While the basic definition is indeed rather straightforward, interested investors should understand many additional aspects of Dividend Aristocrats before making any investment decisions. For any investor interested in equities that deliver increasing dividend payouts over extended time horizons, stocks from the Dividend Aristocrats group should be the first stop in the research process.
Before delving deeper into intricacies of Dividend Aristocrats, let us first take a quick look at the overall index that contains the stocks in question.
The S&P 500 Index
As indicated in the name, the S&P 500 index contains 505 stocks. Technically, the index contains stocks of 500 companies. However, two classes of stock from five companies included in the index raise the number of S&P 500 components to 505. The five companies that contribute two classes of stock to the S&P 500 index are, Alphabet Inc, (NASDAQ:GOOGL and NASDAQ:GOOG), Discovery, Inc. (NASDAQ:DISCA and NASDAQ:DISCK), Fox Corporation (NASDAQ:FOXA and NASDAQ:FOX), News Corporation (NASDAQ:NWSA and NASDAQ:NWS) and Under Armour, Inc. (NYSE:UA and NYSE:UAA).
Furthermore, another component of the index, Berkshire Hathaway, Inc., also has two classes of stock — NYSE:BRK.A and NYSE:BRK.B). However, only the Class B stock is included in the S&P 500 Index. Berkshire Hathaway’s Class A stock does not trade in any significant volume because of the stock’s high price — $340,780 per share at the end of trading on February 11, 2020. At that price level only 138 shares changed ownership during the full day of trading on Feb. 11. Therefore, this particular class of Berkshire Hathaway stock is not a component of the S&P 500 Index.
The S&P 500 Index Eligibility
All stocks must be issued by corporations domiciled in the United States to be eligible for inclusion in the S&P 500 Index. Additionally, these companies must have their common shares of stock available to the public at one of the major exchanges. Currently all 505 stocks trade either on the NYSE or the NAASDAQ exchanges, with options for the overall index (SFX) available on the Chicago Board Options Exchange (CBOE). Launched in mid-1983, SPX options began trading at modest volume and have expanded to become the most frequently-traded option in the United States.
In addition to being issued by companies domiciled in the United States and available for trading on major exchanges, S&P 500 Index eligibility requires a minimum market capitalization of $8.2 billion. Furthermore, all S&P 500 components must maintain a minimum monthly trading volume of 250,000 shares for the six-month preceding the index’s quarterly rebalancing date. The index rebalances and adjusts components based on eligibility requirements every March, June, September and December. Furthermore, each corporation’s average daily trading value must exceed the float-adjusted market capitalization.
The composition of the S&P 500 Index is a good representation of the overall market for general investors. However, the Dividend Aristocrats group offers a better match for investors looking for securities with long-term dividend income distributions.
Dividend Aristocrats Origin
The S&P 500 traces its roots back to 1923 when the Standard Statistics Company compiled the initial index of 233 stocks. The index expanded and changed significantly over the subsequent three decades, before taking its current name and structure in 1957.
However, the first S&P 500 Dividend Aristocrats list did not come into existence until 1989. The first Dividend Aristocrats list contained only 26 companies. Like the S&P 500, the Dividend Aristocrats list continuously changed through quarterly rebalancing. However, while also a quarterly event like S&P 500 rebalancing, the Dividend Aristocrats list rebalances on a slightly delayed schedule. The Dividend Aristocrat’s rebalancing occurs in January, April, July and October, which is one month after the March, June, September and December schedule of the S&P 500 Index.
With the quarterly rebalancing, the number and makeup of the Dividend Aristocrats list components changed quickly after its introduction in 1989. By 2001, the list expanded to its highest level and included 64 companies. The list reduced to 52 companies by the 2008 financial crisis. In the aftermath of the financial crisis, the number of S&P Dividend Aristocrats fell to just 43 companies by 2009. However, the list has been expanded again with the market recovery. Currently, there are 57 Dividend Aristocrats on the list.
Being a component of the S&P 500 Index is one of the main requirements for Dividend Aristocrat designation eligibility. Initially, all companies also had to have market capitalization of at least $3 billion to qualify for the Dividend Aristocrat title. However, the minimum market capitalization for S&P 500 eligibility has risen to $8.2 billion.
Therefore, the $3 billion minimum capitalization for inclusion in the Dividend Aristocrats list is outdated. All companies that meet the $8.2 billion market capitalization minimum for inclusion in the S&P 500 Index automatically meet the now obsolete $3 billion Dividend Aristocrats minimum. Therefore, in addition to inclusion in the S&P 500 Index, the only other major condition for the Dividend Aristocrats designation is a record of consecutive annual dividend hikes for at least the last 25 consecutive years.
In addition to these two major requirements, Dividend Aristocrats also must have an average daily trading value of at least $5 million during the three-month period before the rebalancing date. Moreover, the Dividend Aristocrats group must have at least 40 components and meet the sector diversification requirement. Using the Global Industry Classification Standard (GICS) to calculate the total market capitalization by sector, the total market capitalization of any single sector of the economy can not exceed 30% share of the Dividend Aristocrats group’s total capitalization.
Why 25 Years?
Is there a significance to the 25-year minimum requirement for the Dividend Aristocrats designation? The 25-year minimum requirement does not carry any particular scientific implication. Actually, financial institutions and investors have established several other groups of dividend-paying equities with different eligibility criteria.
For instance, to claim the S&P 500 Dividend Kings designation, companies have to deliver annual dividend hikes for at least the past 50 consecutive years. However, this high threshold results in a list of just 16 companies that meet the necessary requirements. While these companies certainly have impressive records of consecutive annual dividend hikes, the small number does not offer enough diversification to meet strategic long-term goals of most investment portfolios. Therefore, the lower entry threshold and more than triple the number of eligible equities in the Dividend Aristocrats group provides investors with a wider selection from which to choose stocks best suited for their individual portfolio strategy.
In addition to the two S&P 500-based dividend stocks classifications — Dividend Aristocrats and Dividend Kings — investors and financial professionals have established separate groups of dividend-paying equities that have different minimum consecutive dividend hike requirements. Just like the S&P 500 Dividend Aristocrats, Dividend Champions must have at least 25 years of annual dividend boosts. However, the Dividend Champions list is more expansive as it is not limited only to the components of the S&P 500 Index. Also not limited to the S&P 500 components, Dividend Challengers or Dividend Achievers are equities with at least 10 years of consecutive annual dividend hikes. Lastly, Dividend Contenders are equities that have boosted their respective annual dividend payouts for at least the past five consecutive years.
However, the lower entry threshold expands the lists of companies from slightly more than a dozen Kings and less than 60 Aristocrats to hundreds of Champions, Achievers, Challengers and Contenders. Additionally, eliminating the limit to just S&P 500 Index, expands the pool of potential stocks with at least 25 consecutive years of annual dividend hikes — Dividend Champions — to 139. As of January 31, 2020, there were also 274 Contenders (six to 10 years of annual boosts) and 456 challengers (five to nine years of annual boosts). Therefore, there are currently nearly 900 equities that have boosted their annual dividend at least five consecutive years, which could hinder an efficient analysis of potential investment choices.
Even small requirement modifications can expand the number of eligible equities substantially. Dropping the requirement just 20% from 25 to 20 years would almost triple the number of companies in the Dividend Aristocrats group from the current 57 to more than 150. Consequently, while the 25-year cutoff for inclusion in the Dividend Aristocrats group might be somewhat arbitrary, that number keeps the list of eligible companies to a manageable size. This relatively limited number of companies in the Dividend Aristocrats group is small enough to allow for detailed and comprehensive analysis but still offers enough variety to meet diversification objectives of different investment portfolio strategies.
Breakdown by Sector
The 57 companies currently in the Dividend Aristocrats offer a good degree of diversification and represent all 11 GICS sectors. As evident from the graph below, Consumer Staples, Industrials and Financials sectors account for nearly 60% of the group’s total market capitalization.
Compared to the breakdown by sector for the overall S&P 500 represented by the graph below, the overall index’s top sector — Information Technology — accounts for nearly a quarter of the total market capitalization, versus just 1.8% for the Dividend Aristocrats. Additionally, the Industrials sector accounts for more than twice the share among Dividend Aristocrats at nearly 23%, compared to just a 9% share in the overall S&P 500 Index.
Do Dividend Aristocrats Outperform?
Even financial experts and investment professionals do not agree regarding whether dividend income payouts improve the overall performance of an equity. Both sides of the argument make valid points. However, back-tested data indicate that companies with dividends do perform better over extended-time horizons. The companies with rising dividend payouts, such as the Dividend Aristocrats, tend to offer even better returns than equities with fluctuating and unstable dividends.
According to the graph below, Dividend Aristocrats delivered significantly higher total returns –combined capital gains and dividend income distributions — since 2010. Over the past decade, that total gain by Dividend Aristocrats collectively was more than 11% higher than the total return of the non-Aristocrat components of the S&P 500 Index.
Over even longer periods the gains by Dividend Aristocrats are exponentially higher. While the S&P 500 Index capital gains advanced more than 43-fold between 1960 and 2018, total returns with reinvested dividends advanced 246-fold over the same time period. With all other factors remaining the same, reinvested dividends generated additional $5.70 in total returns for every dollar of pure asset appreciation. The graph from a Hartford Funds study below indicates the different returns between the two investment strategies.
Additionally, a study by Ned Davis Research found that S&P 500 equities with rising dividend distributions outperformed all other groups by dividend status since 1972. While equities that paid no dividends tripled in value, these stocks gained only 12% of the overall S&P 500 Index’s total returns. Furthermore, equities that initiated dividend distributions or maintained rising dividend payouts throughout the period performed 2,360% better than equities that did not pay any dividends.
In addition to enhancing total returns and providing a source of steady income, rising dividend payouts over long periods indicate that a particular company has the ability to manage and control its capital efficiently over extended periods. Additionally, rising dividends across multiple decades also illustrate a company’s capability to continuously generate sufficiently high levels of earnings and cash flow to cover its rising dividend payouts, as well as still have sufficient funds to finance business expansion and ongoing operational expenses.
Moreover, to adjust and react effectively through several boom-bust cycles that will invariably occur during a 25-year span, a company must have certain advantages. These advantages can be a unique product or service, offering an exclusive manufacturing or technical process, a strong management team, etc. With these advantages, a company can navigate changing market conditions and maintain positive financial result for long term growth of shareholder assets.
The Dividend Aristocrats group presents interested investors with a concise list of equities that have proven records of steadily rising dividend income payouts and total returns over extended periods. Investors can use this list as a starting point for a more detailed analysis to identify the specific individual equities with the highest returns potential that are also the best fit for the investors’ individual portfolio strategy. However, as with all investment decisions, investors should conduct their own due diligence and stock analysis to select the best equities for maximizing total returns and wealth accumulation over a long-term horizon.
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Ned Piplovic is the assistant editor of website content at Eagle Financial Publications. He graduated from Columbia University with a Bachelor’s degree in Economics and Philosophy. Prior to joining Eagle, Ned spent 15 years in corporate operations and financial management. Ned writes for www.DividendInvestor.com and www.StockInvestor.com.