The Power of Dividends (Especially In A Nine-Year Bull Market)

Written by the William Allan team · Published 2018-02-01T12:00:00.000Z

There is an old saying on Wall Street… “Profits are a matter of opinion, but dividends are a matter of fact.” As we are coming up on a decade long bull market that is coinciding with a massive tax cut for corporations, this saying carries even more weight… especially to dividend thirsty investors. Quite simply, they want to know what these companies are going to do with all these profits! And for good reason, how much will be paid out in dividends!

Dividends have contributed materially to total equity returns in many historical periods, but the contribution varies with the market, index, measurement period, and whether dividends are reinvested. A historical contribution should not be treated as a forecast or as evidence that dividend-paying shares will outperform.

At the end of the day, as investors, we track our success by performance. So, the financial impact of dividends is of utmost importance. Dividend policy can also provide information about a company. Three considerations may help inform the analysis, although none establishes financial strength by itself:

The length of time a company has been paying a dividend. A long payment history can be one data point, but dividends may be reduced or eliminated regardless of past practice.

Whether dividend increases are supported by profits and cash flow. Companies can choose to retain earnings instead, and dividend growth does not necessarily match profit growth.

Whether the dividend payout ratio—the share of earnings paid as dividends—and cash obligations appear sustainable under weaker business conditions.

Shareholders have an economic interest in a business; they do not have an automatic right to receive its profits in cash. Management and the board decide whether earnings should be reinvested or distributed, subject to the company’s obligations and applicable constraints. If attractive reinvestment opportunities are limited, a dividend may be one use of capital to consider. Investor.gov’s overview of stocks explains ownership, dividends, and shareholder risk.

Dividend commitments can influence capital allocation, but they do not establish that a company is well run or that its shares will be a successful investment. A reduction may reflect financial pressure, or it may preserve resources the business needs. The reason and the company’s circumstances matter.

Both price changes and dividends contribute to total return. Their timing, taxes, and reinvestment effects can differ, so they are not interchangeable for every investor. Dividends deserve attention as part of a portfolio’s return and cash flow, alongside valuation, business risk, and the investor’s objectives.

This commentary is for informational purposes only and is not investment, tax, or legal advice. All investing involves risk, including the possible loss of principal, and past performance does not guarantee future results.