Dividends earn their keep
Growing dividends have historically provided attractive compound returns and are a fundamental attraction of investing in equities. Since 1970, the S&P 500 has delivered annualised compound price returns of 10.1% when dividends are reinvested, compared to 6.7% for price returns over the same period excluding dividends.
Inflation-beating dividends are particularly appealing at present, given very low bond yields and with interest rates looking set to stay below the rate of inflation for a while yet. Although inflation is now falling and interest rates in the US and UK look set to head higher next year, we expect dividend yields to continue beating bond yields as interest rates look likely to remain below inflation for some time.
In our Mid-Year Investment Outlook, we note our continued positive view on high-dividend equities in general, and in UK dividends in particular – yielding an inflation-busting 4.6%, while 10-year UK government bonds yield a relatively meagre 2.6%.
In the UK, higher-yielding equities have in the past outperformed both the broader equity market and bonds during periods of negative real (inflation-adjusted) interest rates. UK dividend yields suffered their biggest ever peak-to-trough drop during the credit crisis, and we believe they can maintain a faster compound annual growth rate than the 7.2% they have averaged since 1970.
Dividends are also much more resilient than prices and have fallen less during periods of crisis. The largest peak-to-trough fall for the FTSE 350 dividend yield since 1970 was 30% in 2008, whereas prices fell 62% from peak to trough during the same period.
Many UK companies are sitting on large cash piles, some of which they are likely to continue returning to shareholders through dividends or share buybacks. And the ratio of earnings to dividends (dividend cover) remains above average at 1.8, suggesting dividends can be sustained at current levels.