There's no such thing as an investment for all seasons, but dividend-paying stocks come close.
When the market rallies, dividend stocks generally post solid but not market-beating returns. If stocks decline, dividend-payers are unlikely to fall as steeply. Part of the reason is that dividend-paying companies are typically mature and large, with steady sources of revenue that hold up when the economy skids. And through good and bad, dividend-payers can be counted on to distribute a portion of their earnings.
What's less well-known is a seasonal performance difference. Dividend-paying stocks typically post better results than non-payers from May through October.
The midyear advantage for dividend stocks is documented in recent research that puts a new spin on the well-known seasonal stock investing advice to "Sell in May and go away." It turns out that selling before summer doesn't necessarily make sense with stocks that pay dividends.
That's how it's been the past two years, when each spring's market gain was wiped out over the summer as investors worried about the European debt crisis and disappointing U.S. economic news. Stocks tumbled, but dividend-paying stocks helped investors limit their losses.
But there's much more than recent history to consider. John Buckingham, manager of the Al Frank fund (VALUX) and Al Frank Dividend fund (VALDX), examined market data from 1928 through 2011. He divided stocks into four groups to measure seasonal performance differences. The first group consisted of stocks that didn't pay dividends. The other three were made up of stocks that paid high, mid-range or low yields relative to other dividend-payers. A stock's yield is the amount of the annual dividend, divided by the share price.
From May through October, the top dividend payers averaged a return of 4.11 percent, while the non-dividend payers lost an average 0.45 percent.
There was a similar pattern for dividend-payers with smaller yields. The greater a stock's yield, the higher its average return during those midyear months.
The reverse was true from November through April. The non-dividend stocks returned an average 8.5 percent, compared with 6.5 percent for the highest-yielding dividend-payers.
The 4.56 percentage point margin for the top dividend stocks from May through October was more than double the two percentage point advantage for non-payers over the rest of the year.
Over an entire year, the top dividend-payers returned nearly 11 percent on average compared with about 8 percent for non-payers. Compounded over the decades, the difference between those returns can really add up.
To come up with the averages, Buckingham analyzed market data compiled by finance professors Eugene Fama of University of Chicago and Kenneth French of Dartmouth College.
Dividend-payers are especially appealing for investors wanting to limit risk, including retirees living on a fixed-income. And Buckingham sees an abundance of risk now: "We don't know what is going to happen with Europe and its debt crisis. In this country, our government is staring at a fiscal cliff, and there's a presidential election coming up." He believes that means investors will be seeking to limit their risks, making dividend stocks more likely to outperform.
This dividend fan has plenty of company. Mutual funds specializing in dividend-paying stocks have consistently attracted new cash, while money has been pulled out of other stock fund categories.
Investors deposited a net $26 billion into dividend-stock funds — usually labeled 'equity income' funds — over the 12 month period through May, according to industry consultant Strategic Insight. During that period, a net total of $174 billion was withdrawn from all other stock fund categories, reflecting investors' continuing anxiety.
One current appeal is that most dividend paying stocks offer higher yields than Treasury bonds. Consider that investors committing to lock up their money for a full decade have been paid just 1.6 percent recently for buying U.S. Treasurys. In contrast, the average yield of dividend-paying stocks in the Standard & Poor's 500 is around 2.7 percent.
However, investors shouldn't forget that dividend stocks are substantially riskier than Treasurys, no matter how shaky government finances may seem. Companies such as Bank of America and General Electric had reliably increased their dividends for decades, but suddenly cut them in 2009 to conserve cash when the market hit bottom.
Many companies have since restored dividends to pre-financial crisis levels. But the cuts were especially painful because they came after declining stock prices had already slashed investors' savings.
Whether stocks are rising or falling, the value of dividends is hard to dispute. The income they generate has represented 42 percent of stocks' total return dating to 1926, according to Standard & Poor's.
"They tend to outperform, and do it with lower volatility," says Buckingham. "And for most investors, that's where you want to focus attention."
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