Dividend stocks: the real panacea?

With reliable regularity, analysts emphasise the advantage of investing in high-dividend stocks. These stocks are said to be more solid, to provide protection against inflation, to generally perform better and to belong into the portfolio more than any other stocks. Where does this positive bias come from? Are these stocks also useful against dandruff and sweaty feet?

First of all, it is clear that it is not the distribution in the form of the dividend that is central, but rather that this is only a part of the overall performance – and ultimately this is what counts. In other words, every franc of dividend paid out reduces the value of a company by that same franc.

Theoretically, there is also no reason why high-dividend stocks should be more attractive from an investor’s point of view. Using the so-called dividend irrelevance theorem, it can be shown – naturally under a number of model assumptions – that the dividend level of stocks has no influence on the performance of the investor’s portfolio. If the company optimizes its dividend strategy, the size of the dividend is inversely proportional to the ratio of (risk-adjusted) return on internal company projects and the potential return on the investor’s investment alternatives. In simpler terms, companies optimally pay higher dividends when they no longer have enough profitable internal investment opportunities, and the investor actually has “better” alternatives.

In practice, differences can very well be observed between portfolios with a focus on dividend stocks and those without such a focus. It should be noted that classic equity indices with a focus on dividends are not exclusively based on dividend yields, but also on other criteria such as dividend sustainability and others.

 

The reasons for this divergent performance are primarily to be found in portfolio concentrations caused by this focus:

• Large and mature companies: A focus on high-dividend stocks initially means favouring larger and more mature companies. Young and growing companies usually do not pay dividends, as the money is used for further expansion.
• Shift in sector weightings: Along with this weight shift, more stable sectors are also preferred – classic sectors with low growth and high stability.

From a technical point of view, a dividend represents nothing more than a (partial) return of the invested capital. The sooner and faster this happens – a high dividend, in other words – the lower the risk of an investment.

Taken together, this actually leads to a lower-risk portfolio being created by focusing on high-dividend stocks, which, however, can also show strong concentrations. For example, if a portfolio of the twenty highest dividend-paying stocks in the Swiss equity market were to be compiled, eleven stocks would be from the financial industry – even though this sector accounts for just 17% of the overall market.

With a focus on dividends, a lower-risk and possibly better-performing portfolio is actually constructed – but it is not the dividend that is the cause of this, but the shifts in the portfolio resulting from the focus on dividends.