Dividend Strategies Can Really Add Up

Hans-Jörg Naumer | 25/01/2016
Dividend strategies

Summary

Dividend-paying strategies can be the key to weathering stormy markets, adding portfolio stability, enhancing performance and pointing to the overall health of a business. Oh, and did we mention the added income from distributions?

Key takeaways:

  • Dividends can create added value for a portfolio in the long run – and not just in terms of additional income from profit distributions.
    Stockpicking should not focus on recent profit distributions, which might have come from a company’s equity capital, but on future expected dividends.
  • A comparison of global bond and dividend yields shows that, particularly in times of financial repression, dividends can be an attractive substitute for bond coupons.
  • Historically, dividends have made a significant contribution to total equity returns and have shown a steadier performance than corporate earnings. Thus, they have helped to stabilize securities portfolios.
  • Stocks of dividend-paying companies have turned out to be less volatile than stocks of companies that do not pay dividends.

Dividends in the face of low interest rates

We are currently witnessing a turning point where the huge debts of industrial countries and global imbalances have to be eliminated in order to restore confidence among market players. The process of restoring equilibrium is accompanied by a phase of financial repression where investors are faced with a prolonged period of low or even negative real interest rates in the developed world.

The risk/return profiles of dividend strategies definitely look interesting in precisely this situation. They combine the benefits of currently high dividend yields with historically low share price volatility, while at the same time protecting against inflation. Historically, the gap has rarely been so wide between dividend yields and the yields on government and corporate bonds, at least as far as European companies are concerned.

When it comes to predicting the future success of dividend strategies, investors are focusing on two issues in particular: How sustainable are the relatively high dividend yields in the present market environment? And what are the benefits of dividend strategies for investors with a long-term horizon?

Dividends – a key driver of performance when real interest rates are low

By international comparison, European companies in particular pay high dividends, as demonstrated by an average dividend yield across the market of 3.3% at the end of 2015 (based on the MSCI Europe Index). Expected dividend yields in a portfolio could be further increased by focusing on securities that pay out particularly high dividends. Outside of Europe, other regions also offer dividend yields that are higher – in some cases considerably higher – than the returns on 10-year government bonds. Companies in Australia, New Zealand or Norway in particular have shown themselves to be generous with their dividend payouts.

At the same time, dividends have proven their ability to enhance the stability and real performance of a portfolio. In the past, investors in European equities in particular have enjoyed substantial dividend payouts. On a five-year rolling basis, dividends have made a consistently positive contribution to the MSCI Europe Index performance since 1970, enabling them to partially offset or at least mitigate (1970 to 1975, 2000 to 2005) the effects of share price losses. Dividends accounted for about 39% of the total annualized return of equity investments for the MSCI Europe Index over the entire period. Dividends also contributed more than one-third to total performance in other regions, such as North America (MSCI North America Index) or Asia-Pacific (MSCI Pacific Index), although the dividend yields themselves were lower in absolute terms.

A look at the US since 1950 shows that dividend strategies have outperformed the wider market in times of both rising inflation (up to 10%) and deflation. This is very interesting since inflating the economy as part of a financial repression programme can be an effective means of reducing the huge debt in the industrialized world, in addition to consolidating national budgets and growth.

If companies continue to pursue their dividend policies and stock prices do not change, equities allow investors to earn a "nice coupon". The key issue is: Just how sustainable is this "coupon"?

How sustainable are dividends?

Two factors that favour stable dividend yields in the present market environment are:

  1. In Europe, the ratio of dividends paid to earnings per share is currently around 66%, back at its pre-crisis level, whereas it is around 38% in the USA and 40% in Asia, which is moderate by historical comparison. Thus, companies in these markets still have ample room for future dividend increases.
  2. Companies are sitting on a lot of cash at present. US corporate net cash flows, for example, total around USD1,960 billion net, which is equivalent to more than 12% of US gross domestic product (GDP) and close to its peak since 1980. Companies have already come a long way in the deleveraging phase following the financial crisis, i. e. strengthening their equity base and reducing borrowings. 

Dividend securities enhance portfolio stability

Promising equities that pay out high dividends do not just offer higher returns though, they also bring more stability to a portfolio. Longer time series are available for the US. They show that the volatility (measured against the 36-month rolling standard deviation) of US equities has been tangibly lower since 1972 among companies that paid dividends compared to stock corporations that did not distribute profits. The same trend is visible among European dividend securities since the 1990s.

Some of the reasons why dividend securities demonstrate value and share price stability include:

  • Dividend policy frequently forms an active component of a company’s strategy. Dividends have an extraordinarily strong signal effect. The market takes a very negative stance when dividends are cut or waived, as this raises doubts about the future sustainability of the enterprise. Companies therefore strive to secure consistent dividend payouts. A comparison of dividends and profits among the members of the S&P 500 Index since 1900 shows that company profits have been subject to much greater volatility. Over the past 13 years especially, earnings volatility was almost 60% on an annualized basis, which was much higher than the 6% volatility witnessed in dividends each year.
  • High distributions and the commitment to paying them consistently in view of the signal effect tend to produce more disciplined companies. They need to budget their financial resources carefully and use them efficiently. By contrast, share buyback programmes neither produce a similar signal effect nor do they exert the same disciplinary constraints on a company due to their discretionary nature.
  • Companies with high dividend yields generally have healthy balance sheet ratios with a relatively large equity base and stable cash flows.
  • As a rule, investors are usually less quick to sell off a stock that pays high dividends and promises earnings that can be predicted relatively reliably, even in negative or stagnating market conditions.

Focusing on high dividend payments alone, however, can be misleading. Rather, it is the business model of a company that should shape expectations for sustainable earnings, in addition to a shareholder-friendly corporate policy. Factors such as market share, barriers to entry and pricing power all play an important role in this respect. The right business model can also allow such companies to cushion the effects of inflation by raising prices, which increases both profits and, ultimately, dividends.

For more information, read Dividends Instead of Low Interest Rates.

 

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission (SEC); Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; and Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

Expert-Image

Hans-Jörg Naumer

Global Head of Capital Markets & Thematic Research
Hans-Jörg Naumer is Global Head of Capital Markets & Thematic Research with Allianz Global Investors which he joined in 2000. The focus of his work is on analysis relating to strategic and tactical allocations, specific investment opportunities and the identification of long-term investment trends. Before joining the firm, he worked for Société Générale, where he became the Head of Research Germany and was part of the French investment bank’s international research team. From his vantage point as an analyst and economist, he observed the establishment of the Economic and Monetary Union and thus ranked among the prime “ECB Watchers”. He started his professional career in the corporate banking division of Deutsche Bank in 1994. Hans-Jörg studied economics at the University of Mannheim, one of the leading universities for economics and business studies in Germany. During his studies, he worked at the Chair for Macroeconomics.

Risks Are Rising: Here's What Tops the List

28/01/2016
Risk-Barometer

Summary

Recent risk surveys by the World Economic Forum and Allianz found that while climate change found its way to the top for the first time, what concerned corporations most remained unchanged from the previous four years: business interruption.

The World Economic Forum’s Global Risk Report 2016 found that risks were on the rise. Over a 10-year time horizon, the 750 surveyed experts assessed that the risk with the greatest potential impact in 2016 was found to be a failure of climate change mitigation and adaptation. This is the first time since the report was published in 2006 that an environmental risk has topped the ranking. This year, it was considered to have greater potential damage than weapons of mass destruction (2nd), water crises (3rd), large-scale involuntary migration (4th) and severe energy price shock (5th).1
 

As for business-related risks, the Allianz Risk Barometer 2016 identified the top corporate perils in 2016 and beyond, based on the responses of more than 800 risk experts from over 40 countries around the globe. While business interruption (including supply-chain interruption) remained the top peril for the fourth consecutive year, market developments ranked second and macroeconomic developments came in at position six. This shows that both tougher operating conditions for companies, stemming from increased volatility and intensified competition from new areas, and the macroeconomic environment have increasingly become a reason for concern for corporations.

Top Business Risks 2016 Around the World (click to enlarge)

Top Business Risks 2016 Around the World



Top 10 Global Business Risks for 2016

Top 10 Global Business Risks for 2016

1In this context please note that Allianz Global Investors and Allianz Climate Solutions recently joined the 2 Degrees Investing Initiative (2°II).



Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission (SEC); Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; and Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

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