Interest rates hit record lows in 2020 and likely will remain low until the Federal Reserve has greater confidence in the economic recovery. Treasury yields have risen modestly this year, but real yields, which account for inflation’s effects, have remained negative. Therefore, income-oriented investors should consider looking beyond the Treasury market for securities with the potential for attractive yields.
Dividend-paying equities offer an enticing alternative for investors willing to take on additional risk for potentially higher income. In early 2020, many companies cut or suspended their dividend payouts. The pandemic and ensuing economic downturn pressured many dividend-oriented sectors, including energy, financials, consumer discretionary and real estate.
However, the broad market rebounded quickly, and by the fourth quarter of 2020, dividend payments recovered to reach a new record high. The average annual dividend payment rose 0.7% to $58.28 per share, outpacing the previous record set in 2019 and marking the ninth consecutive year of record payouts.2 We think dividends of higher-quality companies are stable and continue to offer an attractive alternative to low-yielding bonds.
Dividends have historically made up a significant portion of total returns. In fact, dividends have constituted approximately 40% of the total return of U.S. stocks since 1930.3 And reinvesting those dividends over time has typically led to strong performance results. Figure 1 shows how important dividends—and dividend reinvestment—have been to the value of a hypothetical $100 stock investment over a 40-year period in the S&P 500® Index. Price appreciation alone led to a value of nearly $4,418, but reinvested dividends led to a total return of $19,687. That’s a difference of $15,269, more than four times the price appreciation growth.
Reinvesting regular dividend payments has historically boosted investment returns over time thanks, in part, to the power of compounding. Reinvesting dividends means any future earnings and dividends are paid on a higher account balance.
Data from 1/31/1970 - 12/31/2020. Source: FactSet. This hypothetical situation contains assumptions that are intended for illustrative purposes only and are not representative of the performance of any security.
Dividend-paying stocks tend to reside in the value universe of the equity market. Companies in more stable, less cyclical sectors, such as consumer staples and utilities, have historically been more likely to pay dividends than fast-growing companies in cyclical sectors, such as information technology.
Value stocks, however, have underperformed the impressive gains of growth stocks over the last several years, as shown in Figure 2. As of Dec. 31, 2020, large-cap growth stocks were trading at a price to earnings ratio of 37.9, while large-cap value stocks were trading at a price to earnings ratio of 21.7.4 We believe the extreme valuation disparity between growth and value stocks may present opportunities for value stocks and dividend investors.
We think the long period of valuation disparity heightens the chances for the prices of value stocks to increase and the prices of growth stocks to decline. Our experience in prior cycles indicates this reversal of trends can transpire quickly. Should this occur, investors with exposure to value stocks could benefit from the snapback.
We believe dividend-paying stocks have a place in income-oriented portfolios and offer an attractive alternative to low-yielding fixed-income securities. Dividend payouts have recovered from pandemic-fueled setbacks, and the power of compounding could bolster investment returns over time. Furthermore, a potential rebound in value stocks may bode well for dividend-paying stocks.
1Data as of 12/31/2020. Source: Morningstar.
2Saqib Iqbal Ahmed, “S&P dividend payments to investors hit record in 2020 despite virus hit” Reuters, December 30, 2020.
3Data as of 12/31/2020. Source: Morningstar.
4Data as of 12/31/2020. Source: FactSet.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
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