Nov 15, 2019 Equities

Everything you ever wanted to know about dividends

Dividend stocks offer stability and reliable income. But have you ever heard of dividends in kind, or dividend aristocrats? A quick look at ten interesting dividend facts.

  • Reliable but unexciting: that’s the traditional view of dividend stocks.
  • But if you approach these shares from different angles, unexpected horizons open up.
  • The solid foundation that dividend stocks provide in any portfolio remains the most important factor.
6 minutes to read

1. Regular payments are not the same as interest

At a time when bonds are yielding almost nothing or even costing investors money due to negative interest rates, dividend stocks are a highly sought-after alternative. Like bonds, they offer regular, predictable income, though it’s not quite as reliable. While German fixed-income securities offered average negative interest of -0.5 percent in mid-September[1], companies in the DAX 30 index delivered dividend earnings of over 3 percent (November 2019). Overall, DAX 30 companies paid out a record EUR 38.6[2] billion to their shareholders in 2019. But there is one important distinction between interest and dividends: the latter have associated share price risk.

2. Dividends pay half the rent

There are two versions of the DAX: one is the performance index that includes companies' dividend payments (the normal version); the other is the price index, which only shows the increase in value of the shares themselves. A comparison of the two reveals that more than half of the DAX’s performance since it was created over 30 years ago is attributable to dividend payments. If you only looked at share price trends, you would therefore have been settling for lower returns.

Dividend stocks have more of a tradition in the USA than in Europe.

Some listed companies pay out additional dividends in kind.

3. Noblesse obliges

Certain special characteristics distinguish aristocrats. "Dividend aristocrats" are no different. That is the stock-market name for companies whose dividends have been steadily increasing for at least 25 years. The "rule of the best" (which is the original meaning of aristocracy) mainly comprises companies from the USA, where there is a long tradition of paying dividends. Eurozone companies that have joined this elite group can be counted on one hand. They include the German pharmaceuticals group Fresenius, the French cosmetics firm L’Oreal and the Dutch food and beverages company Unilever.[3]

4. Preference shares with an extra kick

Some companies list two different classes of shares: ordinary and preference. Both give shareholders the same rights, except for voting at the AGM. In preference shares, this disadvantage is compensated by an additional dividend or "preference in the distribution of earnings", as it is officially called. The preference may consist of an advance payment from profits (preliminary dividend) or a greater share of profits (supplementary dividend).

5. Dividends in kind: the goody bag at the AGM.

Dividends in the form of items handed out at the AGM can improve share price performance considerably. These items are often products (or coupons for products) that the company produces: chocolate, pens, tickets for a mountain railway trip or suchlike. Unlike cash dividends, these generally do not depend on how many shares a shareholder holds. That means that you can get the full benefit of returns in kind with just a single share. Dividends in kind in the form of food and drink served at the AGM are also very popular with shareholders.

6. Get more from your dividends by reinvesting them

Reinvesting dividends is a powerful way to achieve better returns. If you do not "dine out" on your dividends, you will enjoy the compound interest effect. This means that you don’t just get returns from the capital you originally invested, but that those returns also go to work for you. In the 25 years from 1994 to 2019, the S&P 500 has shown an annual return (excluding dividends) of 7.7 percent. If you include the reinvestment of dividends, this rises to 9.8 percent. Accumulation funds, which do not pay out dividends and automatically reinvest them, can save investors time and effort.

7. Share buybacks: back-door dividends

A company can use available cash to pay a dividend or to buy back its own shares. Buybacks, the argument goes, push up the share price, because the number of shares in circulation is reduced, and so the company's profits are spread across fewer shares. Investors therefore do not immediately share in the company's success but gain indirectly through share price rises and potentially higher future dividend payouts. The advantage is that while tax is withheld at source on dividends, share price gains are only taxed when the shares are sold. However, there is no guarantee that share buybacks will lead to rising share prices – especially over the longer term.

8. Dogs that bite right

"Dogs of the Dow" is a well-known investment strategy in the USA whereby at the start of each year you invest an equal amount in each of the ten shares in the Dow Jones index with the highest dividend returns. The underlying assumption is that companies with high dividends and low share prices may be undervalued and therefore could potentially outperform the overall market. This strategy has not just proven its worth in the last five years. If you had invested regularly in the Dogs of the Dow from 1 January 2000, your holdings would have increased in value by an average of 9.0 percent[4] a year, while the Dow Jones itself managed an average of just 7.5 percent.

Tax on dividends is collected at source. But the tax authorities have to bide their time when it comes to share price rises from share buybacks.

Shares with the highest dividends are not necessarily the best investment.

9. Beware of the trap!

A high dividend payout does not automatically mean that a company is a good investment. If the return is too good to be true, it’s called it a "dividend trap". That is why several other factors should also be your guide. What is the story of the dividend history and dividend growth? Did dividends exceed earnings for a prolonged period and have to be financed from reserves? What was the past earnings trajectory? Does the company have excessive debt compared to its sector benchmark? Investors should not simply have blind trust in dividend levels. That risks an unpleasant surprise.

10. Sleep better at night with dividend stocks

Viewed historically, dividend stocks offer an attractive risk-return ratio. Research[5] has shown that shares in companies with continually rising dividends are considerably less volatile. That is one reason why many investment experts advise you to build your portfolio on a foundation of dividend stocks.

Longterm Performance

09/2014 -09/2015

09/2015
-09/2016

09/2016 -09/2017

09/2017
-09/2018

09/2018 -09/2019

S&P 500

excluding dividends

-2.65%

12.93%

16.19%

15.66%

2.15%

S&P 500

with dividends

-0.61%

15.43%

18.61%

17.91%

4.25%

MSCI World

excluding dividends

-6.86%

9.09%

15.93%

9.17%

-0.18%

MSCI World

with dividends

-4.57%

12.02%

18.83%

11.84%

2.42%

DAX 30

excluding dividends

-0.56%

5.55%

18.84%

-7.22%

-1.69%

DAX 30

with dividends

1.96%

8.80%

22.05%

-4.54%

1.48%

Past performance, simulated or actual, is not a guarantee of future results. Source: DWS Investment GmbH as of November 2019

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1. Source: https://www.boerse.de/historische-kurse/Umlaufrendite-Anleihen-Deutschland/XY0000253194

2. Source: https://de.statista.com/statistik/daten/studie/4761/umfrage/dividendenzahlungen-der-dax-unternehmen/

3. Source: https://aktienfinder.net/dividenden-aristokraten

4. Source: https://www.dogsofthedow.com/dogyrs.htm

5. Source: https://www.hartfordfunds.com/dam/en/docs/pub/whitepapers/WP106.pdf, S. 6

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