How Do You Like Your Dividend Strategy?

Thomas Shipp (00:00):

Investors love passive income, whether from coupon interest on a bond or dividends from a stock portfolio, which is where we'll spend some time today. What's the best approach when it comes to developing an equity income strategy? In this edition of LPL Street View, we'll cover what exactly a dividend payment is, review the concept of an equity income strategy, and analyze two common approaches, high dividend yield and dividend growth, as well as a lesser known strategy, high shareholder yield. But what is a dividend exactly? A few facts. A dividend is a payment made by a company to its shareholders, typically on a quarterly cadence. Dividends are not contractual payments like interest on debt. They are discretionary. Dividends are paid on a per share basis. Dividend yield is the ratio of the annualized dividend per share to the price per share, and about 80% of S&P 500 companies pay a regular dividend.

Thomas Shipp (00:54):

Now that we have the dividend basics down, we'll explore a few common strategies investors employ, the relative benefits of each, and how we think about integrating these principles into our work on the equity research team. The first and likely the most common strategy, would be the high dividend yield approach. This method simply screens a universe of stocks, such as the S&P 500, for the highest dividend yield and purchases a percentage of those stocks. Generally the top 10, 20, or 25%. However, one thing to be mindful of is that a high dividend yield may signal perceived weakness in the business, potentially leading to a dividend cut, leading to further pressure on the share price. This is known as a yield trap, close cousin to the value trap. Next, there is the dividend growth strategy. This approach focuses on owning shares of companies that have regularly grown their dividend per share payments over some period, typically a long enough time to ensure the company is committed to dividend growth.

Thomas Shipp (01:48):

Why look for dividend growers? We point to two primary reasons. One, it signals strength in the underlying business, and two, a growing dividend payment reduces the negative impact of inflation on your income. Finally, we look at high shareholder yield, which adds net share repurchases, or buybacks, to the dividend yield calculation. How does share buybacks provide income to shareholders? Well, as a part owner in the business, you can sell a proportional amount of shares that the company is buying back and still own the same proportional share of the business, but with some additional cash in hand. There are three indexes that track strategies like the three we reviewed, allowing us to see typical characteristics such as historical dividend yields, as well as historical performance. As shown, the high dividend strategy reflected here as the S&P 500 High Dividend Index has the highest dividend yield, followed by the high shareholder yield strategy reflected by the Morningstar US Dividend and Buyback Index.

Thomas Shipp (02:49):

And finally, the dividend growth strategy using the S&P US Dividend and Growers Index, we also include the S&P 500 dividend yield for additional context. Finally, we show the total return of our three dividend strategies reflected using these same dividend indexes, as well as the large cap U.S. market index, the S&P 500. Now, the broad base index performed the best, but only slightly so. The high dividend yield strategy has lagged the other strategies as well as the broad market. Why is that? Some of that has to do with the market environment we have lived through over the last 19 years, but also stocks tend to perform on expectations of growth in the future. And if you apply a strategy of getting paid today and dividends, the thought process goes that you are taking from tomorrow's gains. There's no free lunch when it comes to investing. That's all for now. Thank you for watching and have a great day.