When income matters, dividends still pay

Aug 25, 2020

Bond yields are near historic lows, yet the need for income is near generational highs. Tony DeSpirito offers three reasons why company dividends matter for both growth and income seekers.

As populations are aging, the need for income is growing. Yet interest rates, and government bond yields, are at historic lows. These traditional income engines are falling short of investors’ needs, a scenario likely to persist as central banks hold rates near their lower bounds to prop up economies in the wake of the coronavirus crisis. The Fed has signaled its intent to keep U.S. rates near zero through 2022.

Equity income is an attractive, and I would argue a necessary, alternative. At the end of July, a 10-year U.S. Treasury yield of 0.55% compared to an S&P 500 dividend yield near 2%. Not only are stocks yielding more, but equity income has the potential to grow over time while bonds (true to their “fixed income” label) pay fixed coupons until maturity. Following are three more reasons to like dividends:

  1. Growth and income potential. Dividends do a lot of the heavy lifting in terms of the contribution to a stock’s total return across time. Over the past 30 years, reinvested dividends accounted for more than 30% of global stock returns.*
  2. A marker of strength. The regular payment of dividends is often an indicator of company fortitude. It is a strong statement when a management can still commit to a regular cash payment to shareholders after first paying all costs, interest and taxes, and investing for future growth.
  3. Resilience across cycles. Companies with a record of paying and growing their dividend tend to be better managed. Their CEOs do not want to cut the dividend, so they invest more conservatively in cap ex and M&A and run a more frugal balance sheet. These “dividend growers,” on average, also tend to be less volatile and historically have been able to deliver strong relative performance in all types of markets, as shown below.

Dividend growers exhibit resilience
Historical average return by dividend category, 1978-2019

Dividend growers exhibit resilience


Source: BlackRock. Data from 12/31/78 through 12/31/19. The investment universe is the 500 largest U.S. stocks by market cap. Dividend policy constituents are calculated on a rolling 12-month basis and are rebalanced monthly. Category returns are calculated on a monthly basis. See page 1 for category descriptions. A bear market constitutes a decline of 20% or more. A bull market is defined as the gains between bear markets, which are defined as increases of 20% or more. The aggregate return for the Overall, Bull Market and Bear Market periods is calculated as an annualized average monthly return for the specified market periods, where annualizing takes into account compounding. Shown for illustrative purposes only. Past performance is not indicative of future returns.

Will companies have to cut their dividends in 2020?

These are unusual times, and dividend cuts are inevitable. Companies are built to weather recessions, but not complete loss of revenue. Many will have to take steps to recapitalize their business and ensure their own liquidity. That said, as discussed in The outlook for dividends in the U.S., we see many of the predictions for dividend cuts in this cycle as overly severe.

The key, in our view, is to be discerning. Our research has found that companies with poor operating quality make up the majority of dividend cutters in recessions. This cycle may not be like the last one in terms of the sectors in which the largest cuts may derive. We would be selective in investing in companies with the highest yields, which can be a red flag for a cut. We instead prefer companies with a record of sustaining or growing their dividend across time. We view this as an active exercise and one where deep fundamental research alongside detailed quantitative analysis can make a difference in portfolio outcomes.

Tony DeSpirito
Tony DeSpirito
BlackRock Fundamental Active Equity Investment Team
Antonio (Tony) DeSpirito, Managing Director, is Chief Investment Officer of U.S. Fundamental Active Equity. He is also lead portfolio manager of the BlackRock Equity ...