- On U.S. Equities
- A Growing Dividend Can Add Up
- Don’t overlook the long-term appeal of a rising dividend.
- 2023-08-29 10:11
- Key Insights
-
- The stock market’s strong returns made dividends an afterthought in the first half of the year.
- Dividend growers have outperformed in down and flat markets. They also captured a good portion of the upside in all but the hottest markets.
- Sticking with a dividend growth strategy over a longer period may help to compound returns.
The dividends that some companies pay to shareholders were an afterthought in the first half of 2023. Dividend payers in the S&P 500 gained about 12%, while non-dividend payers rallied 37%.1
"...relative weakness in high-quality dividend growers so far this year may create opportunities."
But an emphasis on high dividend growth can still help investors to tap the power of compounding returns, especially over longer time horizons. And relative weakness in high-quality dividend growers so far this year may create opportunities.
More Than Just Income: A Virtuous Circle of Growth
Dividend growth investing focuses on companies that have the potential to increase the cash payments that they make to shareholders.
Higher interest rates mean that bonds also offer yields2 that are more competitive.
However, the prospect of a rising stream of dividends can offer benefits that may be hard to come by in other investment strategies:
- Strong dividend growth can improve returns and may help to blunt the bite of inflation by providing a rising income stream. Think of it like an annual raise.
- Dividend growers also offer the potential for price appreciation. That’s because stocks tend to track increases in a company’s earnings and dividends over time.
- Reinvesting rising dividends can accelerate the compounding of returns.
A Combination of Defense and Offense
Large-cap dividend growers historically have given up less ground in down markets and outperformed when the market was flat. They’ve also captured a good chunk of upside in better times. However, this group has lagged non-dividend payers by a wider margin in stronger up markets (Figure 1).
These solid returns in a variety of market environments have added up for dividend growth stocks. From the end of 1985 to the end of 2022, the dividend growers in the Russell 1000 Index outperformed this broader benchmark. They also exhibited less volatility.3
Some of this historical resilience reflects the value of dividends in difficult markets. Dividends paid to shareholders are the only portion of a stock’s return that is always positive, so they can act as a bit of a shock absorber when the market is flat or down.
And the discipline involved in paying a dividend—especially one that grows consistently—means that these companies have characteristics that can be appealing in bad and good markets:
- To pay a dividend regularly, a company must generate extra cash beyond what it needs to run and maintain the business. For this reason, dividend payers tend to be established operations have generated significant recurring revenue and ample amounts of this free cash flow.
- Management teams at companies that have grown their dividend consistently are usually focused on returning cash to shareholders and aim to invest in ways that can boost long-term earnings.
Dividend Growers Have Outperformed in All But the Strongest Up Markets
(Fig. 1) Performance in various market environments by dividend policy*
December 31, 1985, to December 31, 2022.
Past performance is not a reliable indicator of future performance.
Sources: Compustat and FTSE/Russell. (See Additional Disclosure.) Analysis by T. Rowe Price.
*The market environments reflect the Russell 1000 Index’s rolling 12-month returns, measured monthly. At the start of every month, T. Rowe Price categorizes the Russell 1000 Index into various categories depending on dividend policy. We then calculate that month’s market cap-weighted returns for each category.
We accumulate the returns during the full periods and calculate the annualized total returns for each category. Dividend growers consist of companies whose dividend growth over the prior 12 months was greater than zero. Non-dividend payers consist of companies whose current dividend yield equals zero.
Still, no dividend payment is guaranteed. Investors need to be vigilant and understand that a company’s circumstances and strategic priorities can change over time, causing a formerly growing dividend to stagnate or, even worse, shrink.
The Power of Dividend Reinvestment
Sticking with a dividend growth strategy over a longer period creates an opportunity to compound returns.
What reinvested dividends contributed to the S&P 500 Index’s total return over the three decades ended last year.4
The effects could be even more compelling for a portfolio of high-quality companies growing their dividends at an above-market rate. Here’s why: The more often a rising dividend is reinvested, the greater the potential effect on longer-term returns.
An experienced fund manager, supported by all the resources of a large investment firm, can add value by pursuing the special companies that have the potential to grow their dividends consistently and strongly over an extended period.
Taking the Long View
Dividend growers may lag during market rallies when investor sentiment and a stock’s momentum seem to take precedence over fundamentals, such as valuation and business quality. But the benefits of focusing on the long term and staying the course with a dividend growth strategy can add up, one payout increase at a time.
We are always on the lookout for any near-term dislocations, broad-based or company-specific, that could create a compelling opportunity in dividend growers that meet our criteria for business quality, earnings sustainability, and free cash flow generation.
Shares of managed care companies that provide health insurance, pharmacy benefits, and health care services came under pressure after their strong performance last year. We believe that our favorites can manage through near-term cost pressures from higher-than-expected demand for medical procedures. They should be well positioned for the long term as they use their scale and innovation to reduce health care costs and improve patients’ outcomes.
Get insights from our experts.
Subscribe to get email updates including article recommendations relating to global equities.
-
1 Dividends are not guaranteed and are subject to change. Past performance is not a reliable indicator of future performance. Dividend payers consist of companies whose current dividend yield is greater than zero. Non-dividend payers consist of companies whose current dividend yield equals zero.
Dividend yield is the yield a company pays out to shareholders in the form of dividends. It is calculated by taking the amount of dividends paid per share over the course of a year and dividing by the stock’s price.
Source: financial data and analytics provider FactSet. Data analysis by T. Rowe Price. Copyright 2023 FactSet. All Rights Reserved. See Additional Disclosure.
2 A bond’s yield is the implied return, at the current market price, that would come solely from the next 12 months of interest payments. Bond prices and yields move in opposite directions.
3 Past performance is not a reliable indicator of future performance.
The dividend growers in the Russell 1000 Index generated an annualized total return of 11.14% and posted an annualized standard deviation of 14.45%. The Russell 1000 Index generated a lower return of 10.31% and posted a higher standard deviation of 16.00%. Standard deviation is a measure of the amount of variation or dispersion of a set of values. A low standard deviation indicates that the values tend to be close to the mean of the set, while a high standard deviation indicates that the values are spread out over a wider range. Sources: Compustat and FTSE/Russell. (See Additional Disclosure.) Analysis by T. Rowe Price.
4 Past performance is not a reliable indicator of future performance. Not representative of an actual investment and does not reflect transaction fees and other costs that may be associated with an actual investment.
December 31, 1992, to December 31, 2022.
Index performance is for illustrative purposes only and is not indicative of any specific investment. Investors cannot invest directly in an index.Source: Standard & Poor’s. (See Additional Disclosure.) Analysis by T. Rowe Price.
Additional Disclosure
The S&P 500 Index is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”) and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). T. Rowe Price is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.
Copyright © 2023, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.
London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). © LSE Group 2023. All rights in the FTSE Russell indexes or data vest in the relevant LSE Group company which owns the index or the data. Neither LSE Group nor its licensors accept any liability for any errors or omissions in the indexes or data and no party may rely on any indexes or data contained in this communication. No further distribution of data from the LSE Group is permitted without the relevant LSE Group company’s express written consent. The LSE Group does not promote, sponsor or endorse the content of this communication.
-
Important Information
Call 1-800-225-5132 to request a prospectus or summary prospectus; each includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
The views contained herein are those of the authors as of August 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Dividends are not guaranteed and are subject to change. The fund’s emphasis on dividend-paying companies could result in significant investments in large-capitalization stocks. At times, large-cap stocks may lag shares of smaller, faster-growing companies. Health sciences firms are often dependent on government funding and regulation and are vulnerable to product liability lawsuits and competition from low‑cost generic product. All charts and tables are shown for illustrative purposes only.
T. Rowe Price Investment Services, Inc.
© 2023 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.
202308-3069533
