Dividends: Only Half of the Yield Story

Tim Strauts: Companies can return capital to investors by paying out dividends or by buying back their own stock. Most investors focus on dividend yield. Because of this, many mutual funds target high-dividend stocks. This focus on only one half of the return-of-capital equation is shortsighted. In today's chart, we're going to look at the dividend and buyback yield of the S&P 500 since 2003.

The columns on the chart show the dollar value of dividends and buybacks by companies in the S&P 500. The green line shows the dividend yield. The blue line shows the buyback yield. Finally, the yellow line shows the total yield, which is the combination of dividend and buyback yields. You'll notice that the dividend yield is remarkably stable. It hovers around 2%, with the only deviation [occurring] during the financial crisis. In 2008, when stock prices fell, companies were slow to cut their dividend payments, so the dividend yield increased temporarily until companies eventually announced dividend reductions. 

On the other hand, buybacks are preferred by management because management compensation is often tied to stock performance, and buybacks help increase the stock price. Also, since cutting a buyback has less stigma than cutting a dividend, buybacks tend to be much more volatile. In the current bull market, the buyback yield has been consistently higher than the dividend yield. When you add the two together, the total yield has been near 5% for the last three years.

Companies that return capital to investors on a consistent basis have outperformed historically. To take full advantage of this phenomenon, investors should look beyond dividend-focused strategies to funds that invest in companies that have above-average total yield.