Four reasons dividends matter now

November 12, 2024

6 minute read

by Matt Quinlan, Portfolio Manager, Franklin Equity Group

With interest rates moving lower and meaningful economic and geopolitical uncertainty impacting the markets, the role of dividends for investors may be especially important in coming quarters. Franklin Equity Group Portfolio Manager Matt Quinlan explores the critical role dividends can play in fueling total return and helping reduce overall volatility for equity investors.

Key takeaways

Today’s investors would be wise to consider the role dividends can play in their portfolio, including:

Significant contribution to total return
Potential to lower volatility
Correlation to high-quality businesses
A broader opportunity set of dividend-paying stocks

Why consider dividends?

As an equity income portfolio manager, I am stalwart in my belief that investing in high- quality companies with the potential to grow over time while generating income can be an excellent source of total return and even more attractive risk-adjusted returns. Today’s environment presents investors with considerable economic uncertainty and meaningful geopolitical tensions around the globe. And with rates on fixed income alternatives heading lower, the value proposition of dividend income looks especially compelling for four key reasons.

1. Dividends play a significant role in total return

Many investors underestimate the impact of dividends on total returns. Since 1926, dividends have contributed nearly one-third of total equity return for US stocks.¹ From 1980 to 2019, a period characterized by a significant decline in interest rates, 75% of the returns of the S&P 500 Index came from dividends.²

Dividends can be particularly important in a declining interest-rate environment, providing a reliable source of cash flow when other fixed income options are less lucrative. Companies rarely stop paying dividends once they initiate them, and most tend to increase the amount of their dividends over time. Paying a dividend can also make a stock more attractive to investors, potentially increasing its value.

Over the past 10 years, dividends for the S&P 500 Index have grown each year and at an average compound rate of just over 7% annually.³ In strong markets, dividends have added to total return. In years when returns were low or negative, like in 2020 and 2022, dividends comprised a larger contribution of total return and helped provide portfolio resilience.

Exhibit 1: Dividends Are Growing

2. Dividends can reduce volatility

Dividends can play a significant role in reducing overall portfolio volatility and can potentially help mitigate losses from a decline in stock price. Studies have also shown that historically, dividend-paying stocks often outperform non-dividend-paying stocks during bear market periods, including the bursting of the tech bubble in the early 2000s and during the global financial crisis.⁴This may be in part because dividend-payers tend to be larger, more established and profitable companies than represented by the broader market, and these businesses are often more resilient.

Over the five years ending September 30,2024, a period that saw wide swings in overall total performance of the S&P 500, equity income funds were less volatile and had lower downside capture than the broader market.⁵

Exhibit 2: Equity Income Strategies Can Be Less Volatile

3. Dividends correlate to high-quality businesses

Since investors typically consider dividends an ongoing commitment, dividend payments require a level of profitability, returns and consistency of cash flow generation. This makes them a meaningful metric to assess business quality. Companies that consistently increase their dividend payments over time demonstrate that their business is steadily generating profits and may be more resilient during market or economic downturns. The chart below shows that dividend-payers within the S&P 500 Index have historically been more profitable than their non-dividend paying peers.⁶

Exhibit 3: Dividend-Payers Can Be More Profitable than Non-Dividend Paying Peers

4. More “growth” stocks are paying dividends

As of September 30, 2024, about 80% of companies in the S&P 500 Index paid a dividend, a number reasonably consistent with the same metric a decade earlier.⁷ However, in 2024, nearly 24% of those companies were in the technology sector—up from 13% a decade ago.⁸ Innovative sectors like health care and industrials also saw meaningful increases among dividend-payers.

Broader payment of dividends has expanded the investable universe, providing equity income investors greater access to higher-growth, dynamic and innovative companies. For example, in recent periods, market-leading companies such as Alphabet, Salesforce and Meta Platforms have all initiated a dividend.⁹ Other established IT leaders, such as Microsoft, Oracle and Broadcom, have shown that paying a dividend does not hinder innovation and reinvestment into new product opportunities. Companies can do both.

Conclusion

An equity income strategy may be an attractive investment vehicle for those seeking a potentially less risky and less volatile way to invest in equities while generating income. The margin and return profiles of many dividend paying stocks are attractive, and we believe that strategies that focus on investing in innovative companies that effectively allocate capital to fund future growth while paying a growing dividend offer investors a compelling opportunity.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

Equity securities are subject to price fluctuation and possible loss of principal.

Diversification does not guarantee a profit or protect against a loss.

Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.

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1. Source: Standard and Poor’s. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.

2. Source: Standard and Poor’s.

3. Source: Standard and Poor’s, Dow Jones and FactSet.

4. Source: FactSet and Lipper.

5. Source: Lipper and FactSet.

6. Source: Standard and Poor’s.

7. Ibid.

8. Ibid.

9. Source: Bloomberg.