Part of the reason it’s challenging to make a black and white determination on dividend strategies is because it’s difficult to isolate dividends as the only variable in the equation. Companies that pay high or growing dividends are often more mature, have a more stable financial condition, and have lower growth rates than companies that do not. This means in many cases, comparing a dividend payer to a non-dividend payer can be like comparing apples to oranges.
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Companies such as General Electric (GE) or Proctor & Gamble (PG), which are high dividend payers, have many other differences to a company such as Netflix (NFLX), which is a non-payer. So, it’s difficult to isolate the difference in the performance of these stocks which is attributable to the dividend payout and the difference attributable to a myriad of other factors. These companies have vastly different business models, dynamics, management teams, competition, valuations, and growth rates. All these factors affect their long run stock performance.
Conclusion
While the evidence on dividend strategies is inconclusive, it’s also possible that these strategies may make sense in certain situations. Investors wishing to implement a dividend strategy should consider the following factors when building their portfolio:
- Costs – Don’t overpay for a dividend ETF. There are many low-cost options available.
- Asset Allocation – Dividend paying stocks are not a substitute for bonds in a diversified portfolio. The risk profile of a dividend paying stock is still significantly different (riskier) than high quality fixed income.
- Sector Overweighting – Be aware of how tilting your portfolio towards dividends may affect your sector exposure. The higher your dividend tilt, the more likely you are sector overweighting without knowing it. Many dividend ETFs also have a significant tilt to value stocks and an underweight to growth.
- Taxes – Higher income means higher taxes for dividends received in a taxable account. Investors may consider positioning dividend strategies in tax deferred accounts such as an IRA.
The future performance of dividend strategies is unclear. Considering costs, asset allocation, sector allocation, and taxes when buying a dividend ETF can give you the best chance for future success.
This article was written by Ryan Gilmer, CFA, who is Vice President – Investment Management at TOPS ETF Portfolios, a participant in the ETF Strategist Channel.
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