Changing macroeconomic conditions have punished growth stocks in recent months. Whether this marks a longer lasting change to equity leadership is unclear, but these conditions create an opportunity to review the case for dividend strategies. For investors, the ability of dividends to contribute towards long-term real return generation is timely.
At Capital Group, we distinguish between dividend payers and dividend growers – companies that pay and consistently grow a dividend – given the latter’s long history of delivering superior returns with lower volatility.
Finding companies that have the capacity and willingness to pay dividends today as well as grow their commitment in future years requires extensive fundamental research. These companies could be positioned to provide strong real returns over the long term.
Growth strategies have long overshadowed dividend strategies. However, changing macroeconomic conditions have turned the tables and dividend investments are enjoying their time in the sun. While this coincides with value’s long-awaited comeback, value and dividend stocks have distinctive characteristics. We believe that dividends deserve to stay in a portfolio even when economic conditions improve. By adopting a fundamental approach to identify companies that can consistently pay and grow their dividends, investors could achieve long-term real return generation throughout the investment cycle.
Finding a complement to growth strategies
The macroeconomic forces that drove stellar equity returns over the past decade are being upended. Inflation continues to reach multi-decade highs and has become more widespread1 than many economists ever imagined. Global economic growth is expected to slow down significantly from 2021’s 6% to 4%2 in 2023 and beyond, and the path towards policy normalisation could still mean further interest rate rises. These dynamics have given way to rising volatility and reduced earnings growth visibility3, putting strain on widely held growth strategies.
As investors contemplate which equity strategies might prevail, finding a complement to growth strategies will be key to achieving long-term objectives – even if growth comes back. Such solutions will likely require:
Resilience in uncertain markets
An ability to select from a broad range of sectors
Long-term real return generation
The road to resilience begins with dividends
Conventional wisdom suggests that value stocks and dividend payers appear well-suited to the current environment, given their heavy reliance on dividend reinvestment for return generation (see Figure 1). Dividends have typically been the more stable component of equity returns over the years, relative to earnings growth and multiple expansion, making it comparable to the tortoise in the well-known “Tortoise and Hare” fable.
There is evidence of dividends’ steady but meaningful return profile throughout the last century; the average contribution to 10-year returns has been 40%4, (although this decreased in recent decades as companies prioritised putting capital back into businesses and share buybacks over returning it to shareholders). Furthermore, except for the 1970s, dividend reinvestment has consistently kept pace with inflation.5 Dividends’ resilience can be seen in stressed markets as dividend payments have shown themselves to be less susceptible to deep cuts than earnings growth.6 In fact, although past results are not a guarantee of future results, when we compared year-to-date equity returns, value (as represented by MSCI All Country (AC) World Value) and dividend payers (as represented by MSCI AC World High Dividend Yield) outperformed other styles significantly in the bear market.7
Figure 1: Dividend-focused strategies can complement growth-focused strategies
Past results are not a guarantee of future results. MSCI AC indices returns from 31 July 2012 to 31 July 2022, shown in US$ and with net dividends reinvested. P/E: price to earnings. Sources: Refinitiv, Capital Group
Value stocks and dividend payers are not synonymous
Value stocks and dividend payers feature distinctive characteristics and behaviours. MSCI AC World Value, for example, has high cyclical exposure (based on MSCI’s methodology8) due to the consistently large weighting in financials over the past 20 years. In contrast, high dividend payers, as measured by MSCI AC World High Dividend Yield, have traditionally been more defensive given the index’s large position in health care and consumer staples. Interestingly, energy, a sector that has been an increasingly noteworthy contributor to returns, has become a significant underweight (7%) in the dividend payer index. These significant differences have meant that value stocks on aggregate have experienced weaker profitability, dividend growth and earnings growth compared to dividend payers (see Figure 2).
Figure 2: Value stocks have had weaker profitability, earnings growth and dividend growth
Past results are not a guarantee of future results. Data for MSCI AC World indices from 31 July 2002 to 31 July 2022. Sources: FactSet, Capital Group
Return on invested capital is a profitability ratio that measures the earnings acquired after tax but before interest is paid relative to invested capital.
EBITDA margin is an indicator of financial condition and measures operating profit relative to revenue. Sources: FactSet, Capital Group
When it comes to downside characteristics, MSCI AC World Value has outperformed MSCI AC World in only one out of the six market corrections (defined as declines less than 20%), since the global financial crisis (GFC). In contrast, MSCI AC World High Dividend Yield has fared better on four occasions.The greater resilience of dividend payers can be attributed to the higher contribution of dividend reinvestment on the returns of these companies, as well as to their lower earnings growth volatility.9 That said, in a bear market, dividend payments have been known to be subject to the same macroeconomic risks that affect capital gains.
1. The Return of Global Inflation, February 2022. Source: World Bank
2. World Economic Outlook, April 2022. Source: IMF
3. Q222 Earnings Insight report. Source: FactSet
4. Based on S&P 500 total returns in US$ from 1930 to 2021. Source: Ned Davis Research
5. Based on returns from 31 January 1938 to 28 February 2022 in US$ for S&P 500. Sources: Capital Group, Standard & Poor’s, Robert Shiller, Morningstar Direct, FactSet
6. Based on MSCI World dividends-per-share and earnings-per-share drawdowns in US$. Sources: FactSet, Capital Group
7. Based on year-to-date returns for MSCI AC World, MSCI AC World Value, MSCI AC World Growth, MSCI AC World High Dividend Yield, MSCI AC World Quality and MSCI AC World Small/Mid Cap with net dividends reinvested in US$ to 30 June 2022. Source: Refinitiv, Capital Group
8. MSCI AC Word Value and MSCI AC World High Dividend Yield are both market cap weighted indices derived from MSCI AC World but with some differences in methodology. The Value index applies z-scores to securities based on their characteristics, which are then aggregated to inform composition. The High Dividend Yield index applies a 5% issuer cap and includes sustainability and persistence of dividend criteria as well as yield to inform composition. Cyclical and defensive references are based on MSCI’s Cyclical and Defensive indices, which divide sectors accordingly. Source: MSCI
9. Period following the GFC is from 30 April 2010 to 30 June 2022. Sources: Refinitiv, MSCI, Capital Group
Risk factors you should consider before investing:
The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment.
Past results are not a guarantee of future results.
If the currency in which you invest strengthens against the currency in which the underlying investments are made, the value of your investment will decrease. Currency hedging seeks to limit this, but there is no guarantee that hedging will be totally successful.
The Prospectus – together with any locally-required offering documentation – sets out risks, which, depending on the fund, may include risks associated with investing in fixed income, derivatives, emerging markets and/or high-yield securities; emerging markets are volatile and may suffer from liquidity problems.
Nisha Thakrar is a senior manager within the client solutions group at Capital Group. She has 19 years of industry experience and has been with Capital Group for 16 years. Earlier in her career at Capital, she was the manager of product development for the European business. Prior to joining Capital, Nisha worked in investment administration and for the FundsNetwork™ platform at Fidelity International. She holds a master’s degree with honours in electronic engineering with computer science from University College London. She also holds both the Investment Management Certificate and the Chartered Financial Analyst® designation. Nisha is based in London.
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Past results are not a guarantee of future results. The value of investments and income from them can go down as well as up and you may lose some or all of your initial investment. This information is not intended to provide investment, tax or other advice, or to be a solicitation to buy or sell any securities.
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