Dividends and the Market Performance of the Stocks that Make Up the S&P 500

Hartford Funds has a fascinating white paper on the importance of dividends to the individual stocks that make up the S&P 500 (Index: SPX).

The paper builds on analysis done by Ned Davis Research, which considered how the stocks of dividend paying stocks performed when compared to non-dividend paying stocks within the index. What makes their analysis especially interesting is they also considered how changes in the firms’ dividend policies affected the growth performance of their stocks, grouping them into several categories.

Before getting into more details, let’s jump to perhaps their biggest finding. The following chart from the paper visualizes the stock performance for the various groups they defined over the fifty years from 1973 through 2023, as measured by how much $100 invested in 1973 in each grouping would have grown through the end of 2023.

In the following excerpt from the white paper, Hartford Funds describes how the companies of the S&P 500 were grouped according to their dividend policies and summarizes their most significant finding:

Do Dividend Policies Affect Stock Performance?

In an effort to learn more about the relative performance of companies according to their dividend policies, Ned Davis Research conducted a study in which it divided companies into two groups based on whether or not they paid a dividend during the previous 12 months. It named these two groups “dividend payers” and “dividend non-payers.”

The “dividend payers” were then divided further into three groups based on their dividend-payout behavior during the previous 12 months. Companies that kept their dividends per share at the same level were classified as “no change.” Companies that raised their dividends were classified as “dividend growers and initiators.” Companies that lowered or eliminated their dividends were classified as “dividend cutters or eliminators.” Companies that were classified as either “dividend growers and initiators” or “dividend cutters and eliminators” remained in these same categories for the next 12 months, or until there was another dividend change.

For each of the five categories (dividend payers, dividend non-payers, dividend growers and initiators, dividend non-payers, and no change in dividend policy) a total-return geometric average was calculated; monthly rebalancing was also employed.

It’s important to point out that our discussion is based on historical information regarding different stocks’ dividend-payout rates. Such past performance can’t be used to predict which stocks may initiate, increase, decrease, continue, or discontinue dividend payouts in the future.

Based on the Ned Davis study, it’s clear that companies that don’t pay dividends or cut their dividends suffered negative consequences. In FIGURE 7, dividend non-payers and dividend cutters and eliminators (e.g., companies that completely eliminated their dividends) were more volatile (as measured by beta⁵ and standard deviation)⁶ and fared worse than companies that maintained their dividend policy.

Lowest Risk and Highest Returns for Dividend Growers and Initiators

In contrast to companies that cut or eliminated their dividends, companies that grew or initiated a dividend have experienced the highest returns relative to other stocks since 1973—with significantly less volatility. This helps explain why so many financial professionals are now discussing the benefits of incorporating dividend-paying stocks as the core of an equity portfolio with their clients.

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⁵ Beta is a measure of risk that indicates the price sensitivity of a security or a portfolio relative to a specified market index.

⁶ Standard deviation measures the portfolio’s total-return volatility. A higher standard deviation indicates greater historical volatility.

Before going farther, it’s also important to emphasize that these groupings are more dynamic than just companies changing groups whenever they changed their dividend policies. The membership of the S&P 500 has changed with the churn of firms being added and removed from the index over time, so there is survivor bias built into the results. The study is looking at how changes in dividend policy played out for this changing membership.

Let’s look at the dynamics of changing dividend policy that applies for just one firm that has been part of the S&P 500 over the past 50 years: General Electric (NYSE: GE). Looking over its dividend history for a well-established company like GE, we see the firm would have been classified as a dividend grower during much of the period from 1973 through 2008 as the company became one of the largest components of the market capitalization-weighted S&P 500 index.

That status changed in 2009 as GE became a dividend cutter after the company became a basket case under its leadership in that era. Even though it remained poorly led for another decade, the company managed to rejoin the dividend grower list in 2010 and stayed on it until 2016 when it officially joined the “no change” group. In 2017, it rejoined the dividend cutter list and stayed on it until 2019, when its dividend bottomed and it once again rejoined the “no change” club. Since 2023, it has been a member of the dividend grower group in no small part because of improved management.

That recap of history brings us to a significant observation. Throughout much the period of the early 2000s during which GE was a member of the dividend grower group, its stock was underperforming. That underperformance occurred as investors looked ahead and anticipated the company that was becoming a basket case that would have to cut its dividend.

That means the growth of the dividend growers includes GE’s underperformance in much of the early 2000s, which reduces its results. Amazingly, this category still outclasses all the other dividend policy categories by a notable margin. That’s an impressive result.

We’ll close by presenting Figure 7 from the white paper, which presents the average annual returns and volatility by dividend policy for the various grouped components of the S&P 500 index from 1973 through 2023.

The ultimate bottom line: Changes in a company’s dividend-paying policies matter a lot!

References

Hartford Funds. The Power of Dividends: Past, Present, and Future. 2024 Insight White Paper. [PDF Document]. April 2024.