When it comes to investing in the post-crisis era, Canadians have been sounding a lot like Cuba Gooding Jr.'s character in Jerry Maguire: "Show me the money!"
Yes, the humble stock dividend – viewed by many investors as little more than the icing on the cake a few years ago, before a financial crisis and major recession wiped out a decade of capital gains in the equity markets – has become the cake itself for an increasing number of investors. Data from the Investment Funds Institute of Canada show that sales of dividend-focused equity mutual funds for the first eight months of this year have substantially outpaced those of equity funds as a whole, and are even far ahead of bond funds – indicating that dividends have become investors' preferred source for both income and overall returns this year.
We know the typical reasons given: Equity markets are too volatile, and two market collapses in less than a decade leave little confidence they can deliver decent returns on price appreciation alone; the baby boomers are inching closer to retirement, are running out of time and need the assurance of a reliable income stream on their investments; lousy interest rates on other assets have made dividends look relatively more attractive as an income stream.
But whatever investors' motivation, their timing is solid. History shows that we're in the right kind of environment for dividend-paying stocks to outperform.
Tough times pay dividends
In a recent report, economist Peter Buchanan of CIBC World Markets noted that over the past 20 years, price gains on dividend stocks have substantially outperformed the overall market in both Canada and the United States in periods of substandard growth. Canadian dividend stocks beat the S&P/TSX composite index by an average of five percentage points in years when gross domestic product grows at less than 2 per cent, while U.S. dividend stocks trump the S&P 500 by an average of more than nine percentage points in such years – on the basis of price alone. (Obviously, the outperformance would be even greater if the dividend payments were included in the calculation.)
However, in years when GDP grows at better than 2 per cent, the dividend-stock price advantage disappears. In Canada, the dividend stocks eke out a less-than-1-per-cent edge over the overall market; in the U.S., they actually lag the S&P 500 by two percentage points.
Keep clipping coupons
Of course, that makes a lot of sense – investors are drawn to dividend stocks in slow economic times because interest rates are typically low in those times, as is corporate profit growth. So people turn to dividend stocks in search of whatever returns they can get – and their buying, in turn, propels these stocks upward.
Mr. Buchanan argues that given the sluggish economic recovery that appears in store for both countries over the next year or more, the environment for dividend-stock outperformance should stay in place for some time yet – adding to the investor impetus to continue "clipping the coupon" in the equity market by focusing on dividend stocks.
"The recession wasn't normal and the recovery isn't going to be ordinary, either," he wrote, predicting sub-2-per-cent growth in both economies in 2011.
"Those betting that dividend stocks will provide a useful portfolio anchor in that sort of environment have history as an ally."