Rising Dividend Stocks Tend to Outperform Other Equities Historically
Investors looking to buy shares in public companies that generally outperform the market should consider those that increase their dividend payments each year.
Research shows public companies that adhere to a rising dividend policy have tended to reward their shareholders with superior returns, increased income payments and reduced volatility. Such rising dividend policies are an indicator that a company’s management uses capital responsibly to ensure a portion of the cash flow generated each year can support increased dividend payouts.
History has proven the merit of investing in rising dividend stocks, since companies that increased their dividends averaged an annual return of 10.1% between January 1972 and December 2014, compared to average annual returns during that time frame of 7.6% for companies that paid steady dividends and 2.6% for those that paid no dividends, according to Ned Davis Research. With such anemic average returns for non-dividend-paying stocks, the shareholders of those publicly traded companies are in danger of not even keeping up with inflation.
The following chart from Baltimore-based investment firm T. Rowe Price shows that the companies that have a rising dividend policy prove to be the best investments of all, compared to other equities that pay steady dividends, cut their dividends of forgo dividends altogether.
In contrast, companies that pay increasing dividends each year give their shareholders returns that not only can keep up with inflation but generally rise above it. In addition, as prices increase during inflationary times, the profits of companies tend to climb to support dividend hikes.
Rising dividend stocks also provide a way for investors to obtain income without selling shares in a company that might be well worth continuing to hold. And a company that has consistently raised its dividend would tend to reward its shareholders with an increased share price, too.
Of course, companies that pay rising dividends are not immune to the ups and downs inherent in markets. But dividend-paying stocks are good bets to outperform more often than not, based on their track record.
However, it behooves an investor to ensure a company that is boosting its dividend is doing so due to increased cash flow from operations. Events other than improved cash flow from business operations may lead to dividend hikes but do not convey the same positive message about a company’s future.
For example, dividend boosts fueled by debt may allow the management of a public company to pay a dividend but it could come at a steep cost. Naturally, that company must finance the payments.
The management of a company may err by borrowing to pay dividends to retain income-oriented shareholders at a premium price. Such a move might not be in the best long-term interest of the organization.
Another source of heightened dividend payments could come from cash produced by divesting non-core businesses. For example, the sale of a business unit may give a company a one-time injection of cash to raise its dividend payments during a particular period of time but that level of payout might not be sustainable without improvements in the organization’s remaining operations.
As a result, beware of assuming a company’s prospects are heating up just because it is paying a special dividend. Improved cash flow from operations usually funds rising-dividend policies that have been sustained for a number of years, so do not overlook the importance of that financial metric.
Shareholders need to keep in mind that companies can raise their dividend but still fail to produce a consistent increase in their share price, especially in the short term. But on a long-term basis, companies that pay increasing dividends unquestionably have proven their merit.
Paul Dykewicz is the editorial director of Eagle Financial Publications, editor of Eagle Daily Investor, a columnist for Townhall and Townhall Finance, a commentator and the author of a new inspirational book, “Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain.” Paul has written for a number of prominent organizations, including the Wall Street Journal, Dow Jones and USA Today. Follow Paul on Twitter @PaulDykewicz.