Why Dividend Growth Is Back

November 18, 2021

4 minute read

by Stephen Duench, CFA®, AGF Management Ltd.

Equity investors don’t have much to complain about these days. Since bottoming in March of 2020, most stock markets around the world have rallied almost uninterrupted and made huge gains in the process. Yet one thing that many of them have sorely missed during this latest run higher is dividend growth and the extra “oomph” it usually provides to portfolios.

In fact, according to our research, almost no North American companies have increased their dividends since the global pandemic hit almost two years ago – at least when compiled in aggregate. And perhaps even worse, stocks that did grow their dividends haven’t been rewarded for it as they typically were in the past. For example, dividend growers listed on the S&P/TSX composite index in Canada underperformed the broad index by more than 15% earlier this year and they continue to lag today. Moreover, U.S. dividend growers listed on the S&P 500 Index haven’t fared much better, our research shows. (see chart below)

Dividend Growth Performance

Source: AGFiQ with data from FactSet as of October 22, 2021. Performance is based on 12-month rolling average.

Clearly, then, dividend growth has been a disappointment of late, but as tough as it’s been, at least now there are grounds to believe the factor can roar back and soon be a catalyst for outperformance once again.

Among the most obvious reasons for optimism is the idea that better earnings growth will eventually lead to better dividend growth based on their strong positive correlation to each other. Considering the recent spike in U.S. earnings growth to above 30% — the highest level in almost a decade – it’s reasonable to speculate that U.S. dividend growth will range anywhere between 9% to 15% in the near term, and that’s perhaps being conversative. (see chart below)

Earnings Growth vs. Dividend Growth

Source: AGFiQ with data from FactSet as of October 26, 2021. Earnings growth based on six-month forward earnings.

If dividend growth does rise to those levels, it may be expected that North America’s Financials sector will have something to do with it. In particular, after being told by governments to restrict dividend increases at the height of the pandemic, both Canadian and U.S. banks are now cleared to resume them, and some have already begun. Similarly, life insurance companies and REITs should, on average, be ready to raise their payouts, too.

Still, Financials may not be the only sector where investors are likely to find dividend growth opportunities. Energy and Materials are two areas of the market that dividend growth has already spiked more recently, and this should continue given generally strong fundamentals and improving cash flow. At the same time, companies in non-cyclical sectors that exhibit these same traits can also be expected to raise their dividends going forward.

Another positive wrinkle in all of this relates to share buybacks – or the potential lack of them going forward. While it made more sense for companies to repurchase stock than increase dividends last year when valuations were depressed, that may no longer be the case. Not only have valuations risen substantially, making share buybacks more expensive, but a new 1% tax proposal on U.S. corporate buybacks now making the rounds in Washington, D.C., could be an additional strike against repurchasing stock versus paying a dividend.

Of course, none of this guarantees that dividend growers will outperform going forward, but the probability is enhanced for companies that grow their dividend more aggressively than those who don’t, our research shows. So, if dividend growth truly is back, investors may not want to miss out on it.