Investing in dividend-paying stocks has been a superior long-term investment strategy, but you wouldnt know it by recent results.
Dividend payers have outperformed non-payers by nearly 2% annualized since 1972 and with much less risk, according to Ned Davis Research (top chart). However, dividend payers have underperformed in 2015 (bottom chart).
What has caused dividend-payers to lag this year? Market leadership has been narrowly focused on a handful of expensive, non-paying, aggressive growth stocks, especially the so-called FANGs (Facebook, Amazon, Netflix, and Google). Investors have crowded into these stocks as they seek companies that can grow earnings despite an uneven global economy. By contrast, many high-yielding sectors (energy, materials, and industrials) are sensitive to global growth, and have thus struggled.
The underperformance of dividend-paying stocks extends to overseas, where high-yielding stocks (as measured by the Dow Jones EPAC Select Dividend index) have declined 10% this year. Many Commonwealth countries (esp. the U.K., Canada, Australia, and New Zealand) have a strong dividend culture, but have been vulnerable to lower commodity prices.
Now may be a good time to purchase dividend-oriented equity mutual funds. First, low bond yields mean that stocks are a very competitive source of income today (left chart). Second, investors often underestimate the power of dividend growth. The right chart reveals that the dividends generated today by the S&P 500 would equate to a 3.8% yield on an investment in the index made in 2004 (right chart). Third, overseas dividend paying stocks in particular appear to be inexpensive. The aforementioned DJ EPAC Select Dividend index trades at a 37% discount to the S&P 500 based on an average of four metrics (Price/Book, Price/Earnings, Price/Sales, and Price/Cash Flow ratios).