Does Dividend Investing Still Work?

From one perspective, 2024 has been a big year for dividends. Meta Platforms META, Alphabet GOOG, Salesforce CRM, and Booking.com BKNG, all initiated quarterly payouts to shareholders in the first quarter. Nvidia NVDA announced it would raise its cash dividend by 150%. Of the top 10 constituents of the Morningstar US Market Index, only Amazon.com AMZN and Berkshire Hathaway BRK.B don’t pay dividends.

Yet, this positive news comes at a time when equity-income investors may feel the deck is stacked against them. First, dividend yields look paltry compared with the income offered by bonds. Second, share buybacks continue to exceed dividends as a way for companies to return cash to shareholders. Third, relative returns for dividend payers have underwhelmed. The Morningstar US High Dividend Yield Index, representing the higher-yielding half of the US dividend-paying universe by market capitalization, is lagging the broad equity market in 2024. It’s also well behind for the trailing five-, 10-, and 15-year periods.

Equity income investors—of which there are many judging by fund assets—can be forgiven for wondering if dividend-based investing still “works.”

Tough Times for Dividends

Despite interest-rate cuts in 2024, bond yields remain decent. The Morningstar US Core Bond Index’s yield to maturity exceeded 4.6% as of the end of November 2024, which compares with a dividend yield of just 1.2% for the Morningstar US Market Index. Market-level yield has declined in 2024.

Of the new class of dividend payers, only Booking.com will exceed a 0.50% yield. None will show up in dividend indexes anytime soon. While their dividend payments look large in dollar terms, all of the new dividend payers are on track to spend far more on share buybacks than on dividends this year. According to an analysis by my Morningstar Indexes colleague Aniket Gor, aggregate buyback dollars for the Morningstar US Market Index will exceed dividend dollars for the fourth straight year in 2024. Excess cash going to repurchase shares is cash not being spent on dividends.

From a performance perspective, absolute returns for dividend-paying stocks have been strong this year, but they trail the broad equity market. The Morningstar US High Dividend Yield Index is lagging the Morningstar US Market Index 2024, though the return differential is far narrower than in 2023, when the former trailed the latter by 20 percentage points. Dividend payers are also behind for the past five-, 10-, and 15-year periods. Dividend-rich sectors like financial services, consumer defensive, and utilities have looked sluggish next to technology companies like Apple AAPL, Amazon.com, Microsoft MSFT, and Meta Platforms of the world. While technology companies pay more in dividends than they used to, dividend portfolios nevertheless tend to have below-market exposure to the sector that has topped the performance charts in recent years.

Could a ‘Paradigm Shift’ Favor Dividend Payers?

Despite their struggles, dividend investment strategies remain popular. US exchange-traded funds screened or weighted on dividends hold nearly $500 billion in investor assets as of 2024’s fourth quarter (billions more sit in actively managed equity income funds). They’ve received inflows this year, though a fraction of the $70 billion they garnered in 2022—a great year for dividends in relative terms.

The experience of 2022 shows that a change in market conditions can cast dividend payers in a very different light. The Morningstar US High Dividend Yield Index declined by only 1% that year even as the broad equity market lost nearly 20%. Light exposure to plummeting technology stocks, lots of constituents in defensive sectors, and twice the market’s weight worth of high-flying energy shares boosted the dividend index in 2022. Then the launch of ChatGPT in late 2022 made artificial intelligence the market’s dominant investment theme, leaving dividend payers look sluggish. Interestingly, dividend payers have fared better outside the US, judging from the track records of the Morningstar Global ex-US High Dividend Yield Index and the Morningstar Global ex-US Dividend Growth Index. That goes for 2024 and the longer term.

Beyond the vicissitudes of market leadership, there’s the potential for a “paradigm shift” in the US equity market favoring dividends. The Ownership Dividend by historian and fund manager Daniel Peris chronicles the centuries-long “tangible cash relationship” that companies maintained with their owners through regular payouts. Peris, who joined us earlier this year on The Long View podcast, envisions a renewed “cash nexus between investor and investment,” where share-price appreciation alone is insufficient. Peris sees capital gains as a “market outcome” and dividends as a “business outcome.”

Competition from cash and bonds, in Peris’s view, might be a catalyst. With interest rates unlikely to return to rock-bottom levels seen in the years following the 2008 global financial crisis and the pandemic, companies may feel pressure to raise their dividend payouts. Higher borrowing costs also diminish the appeal of share repurchases and investments backed by debt. Peris sees a more uncertain geopolitical environment as contributing to a more cash-in-hand investment mentality.

What It Means for Dividend Investors

Over the very long term, dividend payers boast an impressive track record of total returns. According to the data we pulled from the French Data Library and displayed in this paper, dividend payers outperform nonpayers, and high yield is the best-performing income segment of the US equity market going back to 1927. Why? Several reasons have been proposed, from the weeding out of speculative companies, to the discipline the dividend commitment instills in corporate managers, to dividend payers benefitting from the “value effect”—the phenomenon of stocks with lower valuations having outperformed. Of course, there’s no guarantee that this advantage will persist. Recent experience in the US shows that dividend investing can endure extended periods of underperformance just like any other deviation from the market.

Yet, dividends could be a means of connecting investors to their portfolios and keeping their focus on the long-term. Continued inflows into dividend-screened ETFs even in down years like 2024 is encouraging. Perhaps, dividend investing is less about performance chasing than other strategies. If so, investors will be less likely to buy them high and sell them low, thereby suffering the shortfall quantified in Morningstar’s Mind the Gap study.

The key to success with dividend investing is to avoid letting income come at the expense of total return. Chasing the market’s highest yields can lead investors into risky stocks, industries, and sectors. “Dividend traps” are stocks that lure investors with yields that ultimately prove unsustainable. Screening for companies with the wherewithal to maintain their payouts is therefore critical. Whatever the future holds for dividends, total return should remain paramount.