Dividend stocks are shares issued by companies that pay out dividends on a regular basis, and dividend investing has been gaining popularity among investors over the years. The total U.S. dividend ETF assets have grown nearly 10-fold over the past 10 years [1]. Is dividend investing still a good choice for your portfolio? Let’s dive into several facts to talk about how dividend stocks performed over different regimes compared to a broader market.

The Case For Dividend Investing

Risk and Return

Source: BlackRock
The chart above displays the risk and return characteristics for different groups of the 500 largest U.S. stocks by their dividend policy between 1979 and 2019. The group of “Dividend growers & initiators” represents companies that either increased or initialized their dividend distribution. “No Change category” represents companies that pay dividends but with no increase or decrease in distribution. “Nonpayers” represent companies that do not pay dividends. “Dividend cutters & eliminators” represent those that either cut or eliminated their dividend distribution. Over the 40 years, dividend-paying stocks delivered similar or better total returns than non-dividend payers, and certainly much better than companies that cut or eliminated dividends. Regarding stock risk, dividend-paying stocks presented lower risk than non-dividend payers or cutters/eliminators.

From the risk-return point of view, dividend-paying stocks look really attractive, and if your investing horizon happens to coincide with that 40 years you might enjoy pretty good returns by investing in dividend stocks. As a matter of fact, it was calculated in the same study that the dividend part of the S&P500 index total return count more than price appreciation over the two decades between 1987 and 2019.

Performance comparison during Bull and Bear markets

Dividend-paying stocks delivered competing returns during bull markets and bore fewer drawdowns during bear markets. As a result, dividend investing tends to have less downside risk. To understand this empirically, stocks with stable dividend distributions act like bonds that pay coupons periodically, and bonds typically have a lower risk. As a matter of fact, dividend stocks have a higher duration(or sensitivity to bonds) than non-paying stocks based on their historical performances.

Source: Refinitiv, BlackRock

The Case Against

Recent Behavior of Dividend Stocks Has Been Unusual

If dividend stocks are so attractive, what’s not to like them? Well, history does not always repeat itself. The table below shows the performance comparison for the last three market downturns[2]. During the latest two scenarios, especially during the Covid sell-off, dividend stock investing has not been as satisfying as it used to be, at least in the U.S. Take the “S&P 500 High Dividend” index as an example, it delivered around -6% return during the Tech bubble downturn, during which S&P 500 index had -47% return. In contrast, the former delivered around -70% and -46% during the Financial Crisis and Covid respectively, compared with -55% and -34% of the “S&P 500” index. While some other dividend indices fared better during Financial Crisis, they all performed similarly during the covid sell-off.

So what’s different about the Covid sell-off? According to the article[2], several stock factors such as volatility and beta behaved unconventionally this time based on stock factor analysis. From a sector perspective, Utilities and Information Technology also had unconventional behavior during the Covid sell-off.

Dividend Cuts and Suspensions, and Performance since Covid recovery

Since the start of Covid, many companies have been announcing dividend cuts and suspensions[3]. Even though these actions have started to normalize, the overall performance of the dividend stocks hasn’t been quite satisfying since the market started to recover from the crisis. In fact, “global dividend equities lagged the broader stock market by 16% in 2020 and fell behind growth stocks by more than 30%, which these dispersions are far less pronounced during previous years. “[3].

Source: Alliance Bernstein

Tax Consideration

Ordinary dividends are taxed at a marginal income tax rate and can go as high as 37% according to IRS, while realized capital appreciation from stock investment normally is taxed based on whether the profit is long or short-term.

Dividend Stocks In a Rising Rate Environment
It is widely expected that the Fed will raise the interest rate in the near future, “reflecting a growing consensus that gradually tighter policy will be needed to keep inflation in check” [4]. As such, it is interesting to take a look at how dividend stocks performed during the historical rising rate environments. According to a study composed by Global X[5], High Dividend stocks outperformed the market in 7 of the last 10 observed rising rates regimes, and in the periods they underperformed all three cases happened among the most rapidly increasing rate environments.

Source: Global X
Many economists expect the next interest rate hike to be gradual, and if that does happen it could be good news to dividend stock investors.

To conclude, dividend stocks behaved differently during the recent crisis compared to history, and it is yet to see whether companies continue to normalize their dividend distributions and how the Fed is going to hike the interest rate in the future, assuming it happens.

Reference
[1] https://www.ishares.com/us/literature/investor-guide/deep-dive-into-dividends-investing-guide-en.pdf
[2] https://www.spglobal.com/en/research-insights/articles/why-did-dividend-indices-underperform-during-the-coronavirus-sell-off
[3] https://www.indexologyblog.com/2020/05/05/impact-of-dividend-announcements-on-sp-dji-dividend-indices/
[4] https://www.reuters.com/business/fed-policymakers-see-upward-march-interest-rates-starting-next-year-2021-09-22/
[5] https://www.globalxetfs.com/content/files/High-Dividend-Stocks-In-Rising-Interest-Rate-Environments.pdf