Saturday, November 13, 2010

Since the Subprime Crisis Began, Higher Dividend Growth Has Been Rewarded -- Up to A Point

We recently completed an analysis to determine how companies with rising dividends have fared during the last three years, a time when overall dividend payments by S&P 500 companies were falling. 

We divided all dividend-paying companies in the S&P 500 Index into quintiles ranked according to their average annual dividend growth over the past three years. A sixth group consisted of those companies that do not pay dividends.    We then computed the average total rate of return for each quintile over the three years. 

The results are impressive and a bit surprising.  The seventy companies with the highest average annual  dividend growth rates over the past three years have outperformed 58% of all stocks in the S&P 500.  By contrast, the companies with the lowest average annual dividend growth  rate (actually a loss) only outperformed 28% of the stocks in the S&P 500.  Here's the ranking for all dividend-paying quintiles and non-dividend payers:

  1. Quintile with the highest average 3-year dividend growth outperformed 58% of all S&P 500 stocks.
  2. Second highest quintile outperformed 61% of all stocks. 
  3. Third highest quintile outperformed 53% of all stocks.
  4. Fourth highest quintile outperformed 51% of all stocks.
  5. Fifth highest quintile outperformed 28% of all stocks.
  6. Non dividend paying stocks outperformed 48% of all stocks.
To better understand these data, it is helpful to show the 3-year average annual dividend growth rate for each quintile.
  1. Quintile 1:  3-year average annual dividend growth rate of 21.8%
  2. Quintile 2:  11.3%
  3. Quintile 3:  6.1%
  4. Quintile 4:  0.0%
  5. Quintile 5: -28.0% 
The bottom line is if a company began the period paying a dividend and did not cut it, it would have outperformed at least 51% of all stocks.  A company improved its performance relative to all stocks the more it increased its dividend, except for those companies in quintile 1. 

The surprise in the data is that quintile 2 stocks, with an average 3-year year dividend growth of 11.3%, outperformed quintile 1 stocks, which had a 3-year average annual growth rate of 21.8%.

We have two comments about this surprising asymmetrical result: 1) the very high dividend growth observed in quintile 1 stocks was influenced by many large one-time dividend increases among consumer cyclicals and industrial stocks; 2)  In spite of this, we see a similar asymetrical result when comparing earnings growth versus price growth.  The stocks in the quintile with the highest earnings growth did not outperform those in the second quintile. 

Thus, in looking at both dividends and earnings we see that high growth has not been rewarded with proportionately higher price growth. This is the primary reason that we now believe the sweet spot of the stock market is in the high dividend and earnings growth companies.

We will review a few of these companies in the weeks ahead.

Bloomberg data was used for this analysis.