Can dividends offer resilience throughout the cycle?
Client Solutions Specialist Based in London
September 26, 2022
The recent resurgence of value and dividends has motivated many investors to reconsider these investments as growth stocks struggle.
Over the long term, dividend payers have proven more resilient than broad value stocks during uncertain times.
Dividend strategies are not just about investing in high-yielding stocks. Companies with a track record of consistently growing their dividend have rewarded investors over the long term.
At Capital Group, we believe dividend strategies could deserve a place in portfolios even when economic conditions improve, given their ability to contribute towards long-term real return generation. Identifying these resilient companies, however, requires extensive fundamental research.
Rising interest rates, inflation and a significant economic slowdown have disrupted the dominance of growth investing.
Against this backdrop, the FAANGMs (Facebook, Apple, Amazon, Netflix, Google and Microsoft), at the forefront of growth’s market leadership over the past decade, have been hit hard and are illustrative of the pressure building on near-term earnings for such companies. Whether growth stocks ultimately come back or value is here to stay1, however, finding resilience during these uncertain times will require an approach that pays attention to companies’ long-term fundamentals.
For many, the dramatic change in equity market leadership may have led them to reconsider the role of value investing. In this article, we suggest dividend strategies could offer investors greater resilience than value but there is also more to dividends than just investing in high-yielding stocks. Companies with a track record of paying and growing distributions over time have the potential to offer long-term real return generation. Identifying these resilient companies, however, requires deep bottom-up research with a long-term focus.
Uncertain times mean finding a complement to growth
In recent months, we have seen many of the forces that drove equity returns over the past decade be upended. Inflation has climbed to multi-decade highs, for example, and many central banks have had to hike interest rates aggressively as they try to curb spiralling prices. This has put a brake on economies, with global growth expected to slow from 6% in 2021 to 4%2 in 2023 and beyond.
This combination has caused volatility to spike and reduced earnings growth visibility3.
In this environment, growth stocks have been punished more than value or dividend payers. Many growth companies pay no or low dividends, which − as the chart below shows − means their total return depends on earnings growth. These stocks tend to offer high earnings growth in the future, making their present value particularly vulnerable to rising interest rates, as the market discounts future earnings more heavily. In contrast, value stocks and dividend payers have the bulk of their value in near-term cash flows.
These companies tend to pay out a higher share of their profits as dividend income. This makes them better suited to challenging conditions as dividends tend to be less susceptible to cuts than earnings growth: psychologically, companies will avoid reducing distributions to shareholders if they possibly can, as doing so sends a negative signal to markets.
Reinvesting these dividends, rather than taking the cash, has been a major component of equity returns over several decades due to the power of compounding.
Dividends are very much the tortoise rather than the hare when it comes to investment returns but, as anyone who has read that fable will attest, slow and steady usually wins the race. Figures going back over the best part of a century highlight dividends’ steady but positive performance profile, contributing around 40%, on average, to 10-year returns over the period4. (although this has decreased in recent decades as companies prioritised putting capital back into businesses and share buybacks over returning it to shareholders).
Dividend reinvestment versus earnings growth5
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
As investors contemplate what future market leadership might look like, ongoing uncertainty has made finding a complement to growth strategies essential for meeting long-term objectives – even if growth stocks ultimately return to favour. Can value or dividend strategies play this role given their resurgence this year?
Value versus dividend payers
When considering the longer-term opportunity, it is important to understand value stocks and dividend payers are not synonymous – and can therefore display different characteristics and behaviours.
If we look at the MSCI All Country (AC) World Value Index, for example, it has high cyclical exposure due to the large weighting in financials over the past 20 years. In contrast, high dividend-paying stocks, as demonstrated by the MSCI AC World High Dividend Yield Index, have traditionally been more defensive given the weighting to sectors such as health care and consumer staples.
These differences in composition have meant value stocks, in aggregate, have experienced weaker profitability, dividend growth and earnings growth compared to dividend payers, as the chart below makes clear.
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. Return on invested capital is a profitability ratio that measures the earnings acquired after tax but before interest is paid relative to invested capital. Earnings before interest, taxes, depreciation and amortization (EBITDA) margin is an indicator of financial condition and measures operating profit relative to revenue. Sources: FactSet, Capital Group
To expand on this point, value stocks overall have generally been perceived as defensive but our analysis reveals the MSCI AC World Value Index has only outperformed the MSCI AC World in three of eight market corrections (defined as declines of more than 20%) since the global financial crisis (GFC). In contrast, the MSCI AC World High Dividend Yield Index (focusing on the highest dividend stocks from developed countries worldwide) has beaten the MSCI AC World in six of the eight periods. We would attribute this greater resilience to the higher contribution of dividend reinvestment to returns for the latter6.
Value’s recent bounce has been compelling but it is impossible to know whether it will persist and lead to a decisive shift in market leadership. To avoid the difficulties of attempting to time rotations, investors can instead consider dedicated dividend strategies; in doing so, they could benefit from select value stocks but with a potentially smoother outcome.
Dividend investing is about more than high yield: dividend growth matters
While dividend investing has proved its worth in tough markets, our view is that it can also play a key role in generating long-term returns and therefore warrants a strategic place in portfolios. Unlocking its full potential, however, requires a further layer of due diligence, looking beyond stocks that are just high yielding to those with a track record of consistent dividend growth.
Dividend growers are typically higher quality than high yielders, with a history of profit and earnings growth as well as higher returns on assets, equity and invested capital7. Such solid fundamentals allow these businesses to compound dividend income at levels greater than high yielders, rewarding investors with strong gains.
A further benefit of focusing on dividend growth is avoiding some of the pitfalls that can come with high dividend yield investing. Value traps can often be found lurking among the highest-yielding companies, for example, where investors are attracted to an undervalued business that turns out to be cheap for good reason.
Some high yielders also have unsustainable dividend policies and a useful metric to consider here is a company’s payout ratio, which measures distribution levels relative to earnings. A very high ratio can be indicative of limited growth prospects and if earnings deteriorate, a company’s dividend could be in jeopardy. When payouts fell sharply in the Covid-hit 2020, for example, dividend cuts were almost 30% higher for high-yielding stocks according to S&P’s research on US companies8.
Finally, focusing purely on high yielders can mean investors are confined to a narrow subset of stocks. The top 10 holdings of the MSCI World High Dividend Yield Index, for example, account for 24% of the overall market capitalisation, with the top two sectors (health care and consumer staples) making up 42%. In contrast, the top 10 stocks in the MSCI World Dividend Masters Index (a benchmark of dividend growers) account for just 4% of the index capitalisation and those two sectors make up 22%.
Not all dividend payers are created equal
Data as at 31 July 2022. Market capitalization refers to the total market value of a company's outstanding shares of stock. Source: MSCI
Why a fundamental approach matters
Paying out a rising dividend requires companies to have both capital allocation discipline and solid fundamentals. As a result, dividend investing cannot be as simple as just selecting the highest-yielding stocks today. Instead, finding dependable companies with both the capacity and willingness to pay current dividends and grow this into the future requires extensive fundamental research.
Understanding the capacity to make dividend payments over the long term needs more than just robust quantitative research; it also requires foresight to assess whether earnings growth is sustainable. Can payouts be met organically through cashflow from regular operations or will companies have to take on external capital and increase their debt burden? Willingness to pay out rising income is also tied to the quality of a business and therefore requires subjective analysis.
A fundamental approach to stockpicking, such as we employ at Capital Group, is key to identifying these and investing in long-term dividend growers.
Whether growth stocks become favourable again or the value rotation persists, current conditions present an opportunity to build long-term resilience through dedicated dividend strategies. As expectations for weaker economic growth and asset returns set in, we believe dividend growers could become increasingly relevant as a source of long-term real return generation.
 Growth stocks are defined as companies expected to grow their sales and earnings faster than the market average. They typically do not pay dividends and trade at more expensive valuations. Value stocks, by contrast, usually trade at levels perceived to be below their fundamentals; as more established businesses, they also tend to pay out part of their earnings via dividends.
 World Economic Outlook, April 2022. Source: International Monetary Fund
 Based on S&P 500 total returns in US$ from 1930 to 2021. Source: Ned Davis Research
 Price-earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share price to its earnings per share
 Period following the GFC is from 30 April 2010 to 30 June 2022. Sources: Refinitiv, MSCI, Capital Group
 Dividend Aristocrats Viewpoint, July 2022. Source: Proshares
 The Case for Dividend Growth Strategies, June 2022. Source: S&P Global
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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