Updated July 30, 2021 by Bob Ciura

At Sure Dividend, we advocate long-term investments in high quality dividend stocks.

This is because there is a body of evidence that dividend stocks outperform. More precisely dividend growth Outperform stocks.

There’s no better example of this than the Dividend Aristocrats – a group of elite dividend stocks in the S&P 500 Index with 25+ years of consecutive dividend increases.

We’ve compiled a complete list of all 65 Dividend Aristocrats, along with key financial metrics like dividend yield and price-to-earnings ratio. You can download a free copy by clicking the link below:

The long-term performance of the Dividend Aristocrats is shown in the graph below.

Source: S&P 500 Dividend Aristocrats Index Fact Sheet

The Dividend Aristocrats have done very well over the past 10 years, posting a total annual return of 14.5%.

While the Dividend Aristocrats provide evidence, there are plenty of other reasons why dividend stocks – and dividends in particular – may be growth Stocks – are our preferred asset class for long-term wealth accumulation.

This article provides a detailed summary of why dividend stocks are better investments than dividend stocks “just growth” Stocks that don’t pay dividends. We’ll also show you why Dividend Growth Stocks allow you to get the best of dividend and growth stocks, and why we prefer them to one of the alternatives.

The performance of dividend stocks

Dividends have historically been a strong contributor to long-term total returns on the broad S&P 500 index, which includes both dividend-paying and non-dividing stocks.

Between 1930 and 2020, the contribution of dividends to the total return of the S&P 500 was 41%. The image below shows how the number has changed over time.

Source: Hartford Funds – The Power of Dividends

It follows that dividend paying stocks should perform well on an individual basis versus non-dividend stocks.

Dividend stocks have outperformed non-dividend payers while delivering higher risk-adjusted returns as measured by the Sharpe ratio.

There is clearly significant evidence of dividend stocks’ long-term outperformance. The following section discusses the basic reasons why these securities tend to beat the market.

Why dividend stocks outperform

In our view, there are three main reasons dividend stocks outperform non-dividend stocks:

Reason 1: A company that pays dividends must have underlying business operations that actually support this dividend. In other words, equity securities must have income and cash flow in order to distribute them to shareholders – otherwise their dividend payments would not be possible. This means that dividend stocks exclude the riskiest stocks: startups with “upfront profits” and companies that run into bankruptcy or other financial trouble.

Reason 2: Dividend-paying companies have less internal cash flow to fund organic growth opportunities, which means management needs to focus only on the best growth opportunities. Such a keen focus on capital allocation efficiency has a high likelihood of improving a company’s performance over time.

Reason 3: Dividend payments imply that a company’s management is willing to make money from her Control to theirs Shareholders Steering. In other words, it means that the company is shareholder friendly, a trait that is likely to impact other behavior at the C-suite level.

Aside from these business traits, there are other reasons we like dividend stocks.

First, from a portfolio manager’s point of view, dividend stocks are highly preferred as they generate a constant flow of cash that can be used in new investment opportunities.

That dividend income stream is much more constant than stock prices are, meaning investors have the option to buy more Shares at low share prices. The stability of the dividend payments also has a “smoothing” effect on the long-term portfolio performance.

Dividend stocks also avoid the main problem with growth stocks: valuation risk. From our point of view, there are two main risks that investors should avoid in the stock market:

  1. The risk that the business you are buying is a dud.
  2. The risk of overpaying for the company’s stock.

Growth stocks grow fast by definition. Investors are therefore typically willing to pay a higher valuation factor, which means that any temporary disappointment in the company in question can lead to a rapid drop in valuation (and negative returns).

With dividend stocks, this isn’t often a problem. There are usually many dividend stocks that trade at reasonable valuations, which allows budget-conscious investors to buy great companies at fair prices.

In summary, we believe that “dividend stocks” make better investments than “growth stocks”. There is another side of the story; Here’s the counter-argument to dividend stocks versus growth stocks.

There is an alternative to these two options that combines the best of both worlds – Dividend growth stocks. We argue below why dividend growth stocks are our preferred asset class.

Arguments for dividend growth stocks

Dividend growth stocks are companies that pay dividends and steadily grow their dividends by combining the dividend payments of “simple” dividend stocks with the growth of “simple” growth stocks.

A wide range of studies suggest that dividend growth stocks tend to outperform the broader stock market. Research by Ned Davis and Hartford Funds found that dividend breeders and initiators achieved long-term total returns of 13.20% per year from 1973 to 2020, better than the S&P 500’s equally weighted performance of 12.57% per year.

Interestingly, the dividend breeders and initiators analyzed in this study achieved an outperformance with less volatility – a rarity and a contradiction to what modern academic finance theory tells us.

A summary of this research is provided below.

Source: Hartford Funds – The Power of Dividends

While an outperformance of ~ 0.6% per year may not seem like a game changer, it is certainly thanks to the miracle of compound interest.

Using data from the same study, investors who invested solely in dividend breeders and initiators turned $ 100 into $ 11,346. Over the same period, the still good compounding abilities of the S&P 500 index turned from $ 100 to $ 3,764.

Source: Hartford Funds – The Power of Dividends

Stocks that didn’t pay dividends couldn’t keep up with the performance of all types of dividend payers, turning $ 100 into $ 844 from 1973 to 2020. Worse still, the dividend cutters and eliminators fared, turning $ 100 into just $ 56 – meaning these stocks actually lost money.

Clearly, dividend growth stocks have the potential to generate great investment returns. Aside from performance, there are other reasons we love investing in dividend growth stocks.

First and foremost, dividend growth stocks are an excellent option for retirees and other income-conscious investors, as you can see increasing income over time without adding more cash to your investment portfolio. This simulates the wage increases that non-retirees (usually) experience year after year.

Second, most dividend growth stocks are stable, well-established companies with easy-to-understand business models. Notable examples are Johnson & Johnson (JNJ), Wal-Mart (WMT), and McDonald’s (MCD). The stability of these companies enables investors to have considerable security while owning only fractions of an interest in these companies.

After all, dividend growth stocks are here for the long term. When you buy shares in a company that has been increasing its dividend every year for decades, you know that its business model will stand the test of time. When recessions come (as we know they will come), owning dividend growth stocks will allow us to hold course while uncertainty and volatility mount.

Final thoughts

While dividend stocks and growth stocks have their merits, we prefer dividend stocks by far for the reasons discussed in this article.

The great thing about discussing the pros and cons of dividend growth stocks is that you don’t necessarily have to choose. Dividend growth stocks offer the benefits of both dividend stocks and growth stocks while having a track record of long-term outperformance.

If you’re interested in finding individual dividend growth stocks suitable for long-term investing, the following databases (along with the list of Dividend Aristocrats mentioned earlier) are fantastic resources:

Thanks for reading this article. Please send feedback, corrections, or questions to [email protected]


Please enter your comment!
Please enter your name here