Why dividends matter

by Stuart Rhodes, manager of M&G Global Dividend fund

“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in,” said the US industrialist John D. Rockefeller. The principle of owning companies that paid consistent dividends made Rockefeller incredibly wealthy more than a century ago.

The investment strategy that made him the world’s first billionaire is just as relevant today as it was in the nineteenth century.

Dividends are the ultimate indication of a company’s financial discipline and its commitment to shareholder value, in our view. We also believe that a progressive dividend policy helps companies to become better. Why? A company needs to grow its business to support a rising dividend stream, and it needs to do so in a disciplined manner. 

Profitable growth is difficult to achieve in practice, and many billions of dollars have been squandered in the pursuit of unrealistic ambitions. A rising dividend stream regulates the amount of cash that can be reinvested in the business, and therefore only the best and most profitable projects are selected. In other words, the capital scarcity created by the payment of dividends protects management teams from wasting shareholders’ money.

Companies that have embraced this approach to capital allocation have been rewarded for their financial discipline, with higher share prices in the stockmarket. Dividends and share price performance, the two components of an investor’s total return, go hand in hand. It is our strong belief that a rising dividend stream, purchased at a reasonable price, puts pressure on the share price to rise, with the result that the combination of rising income and rising capital leads to excellent total returns over the long term.

Dividend achievers

The tailwind of dividend investing is backed by empirical evidence. There is an elite group of companies in the US known as ‘dividend achievers’ that have increased their dividend every year for 25 years or more. The S&P 500 Index, which represents the 500 largest companies listed on the US stockmarket, has delivered a capital return of 7.5% on average per year in US dollars, and a total return of 9.7% with the inclusion of the income contribution.

The dividend achievers have outpaced the S&P 500’s total return with their capital return alone, and the income has enhanced the total return from dividend achievers to 14.3% per year.

Past performance is not a guide to future performance.

The effect of compounding these superior returns over time should not be underestimated: $1,000 invested in the S&P 500 25 years ago would be worth about $10,000 today. An equivalent investment in the dividend achievers would have increased to almost $30,000.

The US is home to the longest dividend track records, but dividend growers can be found in other parts of the world, from the developed markets of Europe and Japan to other parts of Asia and emerging markets.

Dividend growth vs dividend yield

Dividend investing is often associated with high yield, but it is important to make a clear distinction between dividend growth and dividend yield (which represents the dividend expressed as a percentage of the share price).

A high yield is not necessarily an automatic signal of value; in fact, it can often be a sign of a company in trouble, or a business with limited growth potential. The global financial crisis provided a perfect example when a high yield provided a stark warning sign.

By contrast, our focus is on dividend growth because of its favourable influence on two fronts: the positive effect on a company’s capital discipline and the tailwind it provides for the share prices of these companies. We believe that the combination of these benefits makes dividend growth investing a winning strategy for long-term investors.

Please keep in mind that we are unable to give any financial advice. The views expressed in this document should not be taken as a recommendation, advice or forecast.

Remember that the value and income from the fund’s assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that the fund will achieve its objective and you may get back less than you originally invested.

This information is not an offer or solicitation of an offer for the purchase of shares in any of M&G’s funds.

This financial promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Conduct Authority in the UK and provides ISAs and other investment products. The company’s registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No. 90776.