Dividends are an important part of the investment toolkit, contributing 36% to the total return of the S&P 500® since 1936.1 This sizable contribution has been particularly welcome during the multi-year low interest rate environment and, more recently, as the world has faced economic dislocations induced by COVID-19. In addition to dividend income, investors have been clamoring for higher-quality companies, with sustainable earnings and a less-volatile return profile.
S&P Dow Jones Indices recently unveiled a series of indices that addresses these themes: the S&P U.S. Dividend Growers Index and S&P Global Ex-U.S. Dividend Growers Index. In this blog, we offer an introduction to these indices and highlight their most salient features. In two subsequent blogs, we will explore methodological details and highlight the indices’ characteristics and historical performance.
Focus on Dividend Growth
The S&P Dividend Growers Indices focus on companies that have a history of consistently increasing dividends over multiple, consecutive years (10 years for the U.S. index and 7 years for the Global ex-U.S. index). Put simply, a company’s ability to reliably boost dividends for multiple years should be an indication of a certain amount of financial strength and discipline. Moreover, with limited opportunities for income generation and investor concern around market volatility, dividend growers’ commitment to consistent capital return may provide a more sustainable and stable source of income, potentially with lower volatility (see Exhibit 1).
Avoiding Dividend Yield Traps
Not all yields are created equal. A company’s dividend yield is calculated as its dividends divided by the company’s stock price. It is possible that a company earns a high dividend yield moniker simply through price underperformance, rather than as a result of growing its dividends. The S&P Dividend Growers Indices attempt to avoid these yield traps by excluding the top 25% of the highest-yielding eligible companies. Our research shows that, on average, the highest-dividend-yielding securities have historically proven to be yield traps, having achieved their high yielding status through underperformance (see Exhibit 2).
These lackluster returns could point to underlying business instability, with the highest yielders unfavorably changing their dividend policies, on average, at nearly triple the rate of the index constituents for the U.S. index, and at nearly twice the rate for the Global ex-U.S. index.2 Not surprisingly, these potential yield traps tend to exhibit lower risk-adjusted returns (see Exhibit 3).
Creating a High Capacity Index
When creating an index, one of the most critical considerations is the index’s investability (i.e., how efficiently the index can be replicated). The S&P Dividend Growers Indices were created with an eye toward high-capacity strategies. The next blog will address index construction and describe liquidity thresholds, the multi-day rebalance schedule, our stock weighting approach, and inclusion of every eligible company—all techniques designed to enhance the indices’ investability.
1 Source: S&P Dow Jones Indices LLC and FactSet. Data as of May 31, 2021.
2 We define an unfavorable dividend policy change for consistent dividend growers as dividend elimination, omission, cut, or maintaining same level of dividends.
The posts on this blog are opinions, not advice. Please read our Disclaimers.