Over the years, dividends have accounted for between 40-50% of total returns in the U.S. equity markets, and an even larger proportion in international markets. During the last 10 years, that slipped to just 15% in the United States, when high-growth companies accounted for roughly two-thirds of total returns. We expect that the market will return to a dividend contribution that looks more like the long-term average than what we’ve seen over the last decade.
Conditions look more favourable for dividends than growth
In 2022 we saw a significant shift in the global markets, which — for more than a decade — had been underpinned by a mix of low interest rates, stable inflation and moderate economic growth. This trifecta of conditions had a positive impact on many parts of the market, particularly growth stocks.
Over the past 10 years, this shift, along with events such as the global financial crisis and the COVID-19 pandemic, led to returns that came primarily from growth stocks.
Today, however, those trends have reversed; we now have rising interest rates, high inflation and a potential global recession. In this climate, quality has become more important than ever; dividend stocks in particular are becoming more attractive, as investors look for companies with business models able to perform well regardless of market conditions.
The power of dividends allows investors to compound their returns over time. Below is an example of a $10,000 investment; the dark blue line shows its price-only growth, with no dividends paid, and the pale blue line shows its growth if dividends are paid and reinvested.
Four signs of a “dream team” dividend stock
Not all dividend stocks are created equal, and it’s important to ensure a company is able to maintain stable dividend payouts over the long term. To uncover the best performers, investors should focus on fundamentals in order to understand a company’s revenue model and its commitment to providing dividends.
They also need to understand how and why companies are paying dividends, and how those dividends fit with a company’s business cycle. Mackenzie’s strategy, for example, doesn’t simply assume that dividends equal quality. A high dividend can be a red flag and may suggest the market anticipates a dividend cut.
The revenues and profitability of companies like Coca-Cola and Aon have proven to be resilient through different market conditions.
Mackenzie’s Global Equity & Income Team has identified what it calls a “dream team” list of companies that have high returns on capital as well as fairly predictable long-term economics. The team blends dividend yield with growth; it only owns companies that are growing and that are also able to grow earnings at an attractive rate and raise their dividends over time.
These “compounder companies” range from global household names to smaller, lesser-known, unique companies capable of delivering healthy margins. To identify “dream team” companies, Mackenzie’s Global Equity & Income Team examines each one closely, using these four key metrics:
Resilient revenue streams
Assessing whether or not a company is high quality involves close scrutiny of its operating model and what underpins its profitability and returns on capital. These characteristics can reveal whether a company can maintain consistent dividend payments.
For example, pricing power allows companies to offset the pressure of rising costs due to inflation, without having a negative impact on demand. The revenues and profitability of companies like Coca-Cola and Aon have proven to be resilient through different market conditions. These companies have the resources to keep investing in and growing their businesses, even during a recession.
Commitment to dividends
While companies always have options for uses of capital, dividend payments are a sign of integrity. The team therefore focuses on companies that return unneeded capital to their shareholders, rather than simply retaining it and expanding the corporate empire (which may correlate to higher management compensation, which can be detrimental to shareholders).
High-quality companies generate more than enough cash flow to reinvest in the business. For example, pharmaceutical giant AbbVie, which Mackenzie holds in the Mackenzie Global Dividend Fund*, now generates over US$20 billion of free cash flow per year, reinvesting roughly one-third into research and development to ensure a sustainable product pipeline.
With a payout to shareholders under US$10 billion, the company’s dividend is clearly very well-funded. While share buybacks can be more opportunistic, dividends show that a company has a long-term commitment to paying shareholders. Dividends also indicate the sustainability of a company’s earnings growth.
The right time in the cycle
Whether or not dividends make sense depends on where a company is in its growth cycle. Some companies need to reinvest cash flows back into the business to take advantage of growing opportunities. Microsoft, for example has been spending large amounts of capital on its cloud computing division, Azure, in order to enter a massive new market. In such a case, it can make more sense to spend on building a potential multi-billion-dollar service than it does to pay shareholders.
A company like Visa, on the other hand, could raise its payout ratio, as it typically generates far more cash than it needs to reinvest in the business. The optimal company is one that offers both a higher payout and higher growth.
Regional differences matter
Dividends have historically been higher in Europe than in the United States, in part because of cultural differences and sector weightings. European companies tend to have a greater power balance between executive management and the board than in the United States. In some jurisdictions, it’s a legal requirement to separate the positions of board chair and CEO. In Europe, investors can expect higher payout rates because company boards are more likely to represent shareholder interests.
In North America, CEOs typically dominate the relationship and tend to hold back capital to fund acquisitions, expand employee head count and generally expand the business. Such empire-building often serves management more than it does shareholders because it leads to increases in management compensation.
Sectors also matter. The US is the most dynamic economy in the world, and technological innovation has been a big driver of its growth. In that context, where more capital is invested into the growth of a company, there might be less available for dividends.
The European market contains a much higher percentage of financial companies, which provide an above-average dividend yield. More than a quarter of the S&P 500 is made up of higher-growth companies in information technology, compared to the MSCI Europe Index, where technology accounts for only around 7% of the index.
To discuss ways that dividend investments can complement your clients’ portfolios, talk to your Mackenzie sales representative.
* Holdings as of February 2023.
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