Income-oriented investors love stocks that have a habit of growing their dividends. I confess to being one of them because I've done extraordinarily well by buying such stocks when the market gets a little panicky.
But it turns out that selecting stocks based on past dividend growth generally hasn't yielded much of a performance advantage according to Meb Faber, the chief investment officer of Cambria Investment Management. He recently examined the issue in a blog post called The Dividend Growth Myth.
Mr. Faber was critical of a long-running study from Ned Davis Research, which suggests that dividend growers provide a nice return boost.
Instead, Mr. Faber highlighted a series of new backtests by Dr. Jack Vogel, the CFO and CIO of Alpha Architect, which indicate that dividend growth stocks have been less than exceptional gainers.
One of the tests looked at equally weighted portfolios chosen from the largest 500 stocks in the U.S. using several different strategies. (The results were largely similar for market-capitalization-weighted portfolios.)
The portfolio containing stocks with positive dividend growth gained 12.76 per cent annually from 1982 through 2015 and didn't do as well as the portfolio containing all dividend stocks (those with dividend growth plus those without it), which advanced 13.06 per cent annually. By way of comparison the market portfolio gained 12.73 per cent annually.
As a strategy, dividend growth seems to be weak at best. But dividend investors shouldn't give up entirely because high-yield stocks (those in the top quintile by yield) fared better with average annual returns of 13.54 per cent.
It is important to point out that Dr. Vogel's work focused on the dollar value of the dividends paid by companies and the growth thereof.
Dividend investors usually focus instead on the growth of a firm's dividend per share. The two aren't necessarily the same.
For instance, a company that pays a steady dividend-per-share but issues more shares via overly generous stock option grants will see the total dollar value of its dividend payments rise. Mind you, it isn't the sort of dividend growth that investors are looking for.
Such complications are partially addressed by considering shareholder yield (dividends plus net-buybacks) instead of dividend yield. Dr. Vogel figures that stocks with high shareholder yields (top quintile) gained 15.24 per cent annually from 1982 through 2015. Shareholder yield is often favoured by value investors due to its more comprehensive nature.
Theory is one thing but it's important to take a look at how dividend growth has fared in practice. To do so I'll focus on a couple of popular exchange-traded funds.
South of the border, the Vanguard Dividend Appreciation ETF (VIG) gained 7.34 per cent annually over the 10 years through to the end of April, 2017. By way of comparison, the S&P 500 index advanced at an annual rate of 7.15 per cent over the same period. Much like the theory, the performance difference between the two proved to be minor.
Dividend growth fared better in Canada. The iShares S&P/TSX Canadian Dividend Aristocrats ETF (CDZ) climbed at an annual rate of 6.16 per cent over the last decade despite its hefty annual fee – or MER – of 0.66 per cent. By way of comparison, the iShares S&P/TSX 60 ETF (XIU) gained 4.61 per cent annually over the same period while the iShares Core S&P/TSX Capped Composite ETF (XIC) gained 4.34 per cent per year.
A decade's worth of real-world returns is hardly definitive but the evidence against dividend growth as an outperforming strategy is starting to pile up. As a result, investors should think twice before relying on it when picking stocks and they should focus instead on measures like shareholder yield.