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Taking stock of dividend investing

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Many investors have become fans of dividend investing in recent years. If you lived through the tech wreck of 2000, the post-9/11 markets drop and the world financial system's near-collapse in 2008, you have probably come to appreciate the simple pleasure of getting regular dividend payments from boring companies -- especially if they rise regularly.

The fact so many investors seek out dividends has been helpful in persuading more companies to return value to shareholders directly through dividends. This is important. Academic research has shown many companies do a poor job of reinvesting their profits, especially if they try to diversify by purchasing other companies in different industries. A 2003 paper in the Financial Analysts Journal (with a refreshingly non-academic title: Surprise! Higher Dividends Higher Earnings Growth) found companies that paid out more of their profits as dividends had higher growth in profits.

This may explain another interesting fact many investors are not aware of: There is a growing body of research showing you can actually beat the broad stock market by investing for dividends.

In principle, that's tough to do consistently. Except perhaps for small companies, it is tough to find information about things that could affect a stock's price that haven't already been fully analyzed by legions of analysts and investors. And it is hard for any one investor to be more astute than all of the others. In short, it is hard to get higher returns than the average of all stocks by picking the stocks most likely to outperform.

All that is true, and yet a stream of research from various sources is demonstrating stocks that pay dividends have, over long periods, outperformed those that either cut their dividends or never paid them in the first place. Here are a few examples.

-- Jeremy Siegel, author of Stocks for the Long-Run, divided the stocks in the S&P 500 index into five groups ranging from the highest dividend payers to the lowest and calculated the 2009 value of $1,000 that had been invested in each group in 1957. In the two lowest groups, that $1,000 grew to be less than $100,000. In the top two groups -- those with the highest dividends -- those $1,000 investments rose to more than $400,000. (Cited in Daniel Perris, The Strategic Dividend Investor, p. 27.)

-- A TD Waterhouse report (The Merits of Dividend Investing, Nov. 10, 2011) found the annual growth rate of the S&P 500 since 1988 was 7.5 per cent on stock prices alone, but 10 per cent when dividends are included. For Canada, the corresponding numbers were 6.2 per cent without dividends and 8.9 per cent with them. This report also noted high-yielding stocks are less volatile than the overall market, so "dividend paying stocks can enhance total return for investors, with potentially lower risk."

-- For Canada, RBC Capital Markets (Canadian Equity Strategy, March 23, 2011) found "dividend growers" returned an average of 12.6 per cent between 1986 and 2011 while "non-dividend payers" returned just 2.4 per cent.

-- A subsequent study by RBC Capital Markets (Canadian Equity Strategy, Jan. 11, 2012) concluded "a portfolio of relatively high-yielding TSX 60 stocks consistently outperforms its peers as well as the corresponding large-cap benchmark. The high-yielding portfolio also offers appealing risk-adjusted performance metrics."

-- Daniel Peris's book, The Strategic Dividend Investor, showed this outperformance by dividend stocks was found not just in the United States and Canada but also in the U.K., France, Germany, Switzerland, Japan and Australia over the period 1987 to 2009.

Note that all of these studies cover long periods of time. There is no guarantee dividend stocks as a group will outperform over shorter periods. In fact, the possibility of short-term outperformance by relatively volatile, non-dividend stocks probably explains why investors overall haven't completely abandoned non-dividend stocks. If you are a professional money manager with quarterly and annual targets to meet, it may make sense to trade in such stocks.

But if you have a longer investment horizon (and assuming the historical experience will continue to apply), then the research suggests that high-quality stocks with relatively high and growing dividends will provide better returns.

Stephen Watson is an Investment Adviser at MGI Securities, Inc., in Winnipeg. He can be contacted at SWatson@mgisecurities.com

Republished from the Winnipeg Free Press print edition March 3, 2012 B14

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