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The Power of Dividends: You Can't Ignore the Figures

Dividends and dividend investing is one of those topics that split opinions among at the investment community.

On the one hand, you have those investors who believe that dividends are a waste of time, and usually a waste of shareholder capital. Meanwhile, on the other hand, you have those investors who believe that every company should pay a dividend and those that don't are not worth looking at.

Historic performance

There are positive and negative points to both sides of the dividend argument. However, there is overwhelming evidence showing that over the long term, dividend stocks do produce better returns than companies that do not offer shareholders a regular income.

Some of the most comprehensive research on the power of dividends was published in Professor Jeremy Siegel's 2005 book, "Future for Investors."

In the text, the professor broke down the performance of S&P 500 dividend-paying stocks into quartiles. The companies were separated by dividend yield, from the lowest to the highest and everything in between.

Looking back at performance figures stretching all the way to 1957, Siegel found that over this ultra long-term holding period, the dividend stocks with the highest dividend yields achieved the best performance.

These companies produced an average annual return of 12.5%, outperforming the S&P 500 index, which returned 10.3% per annum over the studied holding period.

The second quartile of highest-yielding stocks returned 12.1%, once again outperforming the benchmark index. However, the stocks in the last three quartiles all underperformed the benchmark index. The middle bracket returned 9.6% per annum, the second-lowest bracket returned 9.2% and the lowest returned 9.4% per annum.

Compounding profits

This isn't the only research on the power of dividend investing. Earlier this year, investment manager Hartford Funds published its own document on the power of dividends.

What the researchers found is that going back to 1960, 80% of the total return of the S&P 500 index can be attributed to the reinvestment of dividends and the power of compounding.

Specifically, $10,000 invested in the S&P 500 index at the end of 1960, was worth just $431,400 at the end of 2018, assuming no reinvestment of dividends. If dividends were reinvested throughout the holding period, this initial $10,000 investment would have been worth $2.46 million at the end of 2018, 470% more than the non-reinvested amount.

Hartford's research also showed that over the long term, stocks with high dividend yields tend to outperform the S&P 500.

Once again the managers separated dividend stocks into quintiles, from the highest to the lowest, and looked at the performance of these buckets from 1929 to 2018.

During this time period, the stocks with the highest dividend yields outperformed the S&P 500 index 66.7% of the time. The second quintile outperformed 77.8% of the time. Stocks with the lowest dividend yields only outperformed the S&P 500 index 44% of the time. The primary difference between the first and second quintile of stocks in this study is the dividend payout ratio.

The second quintile had an average payout ratio of 41% during the time period considered, compared to 72% for the highest dividend payers. This, Hartford concluded, shows that dividend yield isn't the only metric investors should consider when looking for income stocks.

The bottom line

So overall, while some investors might believe dividends to be a waste of shareholder cash, these studies show that over the long term, dividend-paying stocks tend to outperform their benchmark.

This isn't true of some companies. Some businesses, like Berkshire Hathaway, have managed to beat the S&P 500 without distributing profits to shareholders. But these companies are one-of-a-kind.

On average, the data speaks volumes about the power of dividends, particularly for investors with a long-term outlook who are not so worried about near-term performance.

Disclosure: The author owns shares in Berkshire Hathaway.

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This article first appeared on GuruFocus.