Academic and Street research has looked into dividend policy and the performance of stocks for many years. From a purely theoretical standpoint, the argument was that fast growing companies, in constant need of cash and unable to pay dividends, represented more attractive long term investments. Slower growing, more mature, companies paid out dividends because they lacked attractive investment alternatives, and therefore represented less attractive investments. The problem is that history does not bear this out.
Shown below is the cumulative performance since 1980 of stocks ranked by dividend yield. The chart breaks down the Russell 1000 universe of stocks into 10 buckets. Decile 1 represents the top 10% of stocks ranked by dividend yield. Decile 2 represents the stocks whose dividend yield is between the top 10% and the top 20%, and so on. Note that over the last 30 years, all top 5 deciles outperformed the lower paying stocks. Even decile 1, whose dividend yields are extremely high, typically because their stock price has fallen and the dividend is in trouble, outperformed their low or no paying dividend counterparts.
The undeniable fact that higher dividend paying stocks have outperformed has led to a body of research into the “signaling effect.” In short, much of the research has concluded that management adjusts their dividend policy based on the confidence that they have in the long term outlook for their company and the company’s ability to grow their earnings. The more confident management is in their ability to grow earnings into the future, the more comfortable they are in raising the dividend. In fact, studies have shown that management will typically raise their dividend if they feel that the increase in their earnings is “permanent in nature,” versus another shareholder friendly policy of buying back shares of stock if they think that the increase in earnings is more cycle in nature.
The CIP Strategy:
The CIP Dividend Growth Strategy starts by narrowing the universe of eligible securities for consideration to those companies in the top half of stocks ranked by dividend yield (top 5 deciles as illustrated in the chart above). We then apply our proprietary multifactor model to identify those companies that display attractive growth rates, but sell at a reasonable price. The portfolio is diversified using a risk model in an effort to obtain the highest return while assuming the lowest risk.
The final result is a well diversified portfolio of above average dividend paying stocks. The dividend yield has historically rivaled fixed income alternatives in terms of absolute yield, but has the added advantage of growth in dividends historically. That such a strategy is very competitive with the broader market on a total rate of return basis over time.