When assessing the performance of a stock or equity portfolio, it’s essential to understand the various components that contribute to total returns. While price appreciation often takes the spotlight, dividends are often ignored or even dismissed as counterproductive for those committed to a ‘growth’ style of equity investing. Indeed, one of the most noteworthy trend in the investing world is the decline of dividend yield in the US stock market over the past thirty years, from 5-6% in the 1980s to around 1.7% in 2023. Dividends have been pushed to the background while non-dividend securities have taken centre stage in the world of investing.
But do dividends really play an insignificant role in generating wealth? To answer that question we can decompose the stock returns into price appreciation and dividends to calculate their respective contribution to the total stock returns. (i.e. the total return in any measurement period is the sum of dividend received and change in stock price, divided by the starting stock price.) Using Yale’s Robert Shiller database we can get monthly price and dividend data of the S&P500 all the way back to 1926:
According to Shiller’s dataset, the market has grown at a compound annual growth rate of 10.1% since 1926. During the period share prices rose by 6.1% and dividend yield represented the remaining 4% of the market’s annual total return. In other words, roughly 40% of total stock returns come directly from companies’ cash distributions to shareholders. Just this figure alone should suggest that dividends play no trivial role in generating long-term investment returns.
But wait — what if there’s more? As historian turned portfolio manager Daniel Peris points out in his book, The Strategic Dividend Investor, the obsession with calculating short-term performance as the basis for making investment decisions have led investors and financial analysts away from a simple but absolutely crucial question: why did shares go up by 6.1% annually since 1926? The answer is hiding in plain sight but often neglected in standard charts or analysis: distributed profits have grown by that amount. Again using Robert Shiller’s database, the market’s aggregate dividends have grown at a compound annual growth rate of 5% since 1926. That is, of the market’s average annual total return of 10.1% since 1926, 9% of it came from dividends — the base dividend yield represented 4% and capital appreciation attributed to dividend growth provided another 5%.
Not half, but almost 90% of market’s historical return has come from the much ignored dividend payments! The growth in share value independent of dividend on the other hand was just over 1%.
It shouldn’t be surprising that dividends dominate the components of total market returns. It is almost a tautology to state that in the long run the value of companies rises primarily because their distributable profits expand. Why else would investors want to buy a stake in a company if not to access a growing stream of profits – and to be paid for it in cash?