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If you’re of a certain age you’ll probably recall those Got Milk? commercials that were omnipresent in the mid-1990s. It was one of the all-time greatest ad campaigns, becoming a cultural touchstone. Seeing as milk consumption per capita in the US has been decreasing for at least 20 years, the milk producing industry might want to consider dusting off its old playbook. Though not entirely clear why Americans are drinking less milk, the decline is at least partially explained by an aging population.
Demographics might be hurting milk consumption, but aging populations in the US and other major economies are a distinct tailwind for income-producing securities, including dividend-paying stocks. Retirees, a growing share of the overall population (Exhibit 1), are shifting their asset allocations towards income-producing securities and strategies to meet their income needs.
Exhibit 1: Aging Demographics
US Population - Ages 65 and above (% of total)
Source: St. Louis Fed. As of 2021.
However, low yields across fixed income markets are unlikely to provide them the necessary income, even after the year-to-date rise in interest rates (Exhibit 2).
Exhibit 2: Increasing Demand for Scarce Yield
10-Year US Treasury Yield and US Core CPI (Y/Y)
Source: Artisan Partners/Bloomberg. As of 30 Jun 2022.
As an alternative to reaching for yield and taking greater credit and/or duration risk, investors can increase their allocations to income-focused equities. Dividend-paying equities potentially offer superior total return potential compared to fixed income securities because companies can grow their earnings and increase distributions in the future. As business earnings grow, not only can companies increase dividends they can also reinvest excess cash flow into their businesses, thereby enhancing investor’s total return potential. Given companies’ ability to reinvest cash flow and increase earnings power over time, equities offer a better long-term inflation hedge.
In addition to providing more income, dividend-paying stocks have historically been less volatile compared to equities overall, providing some cushion during market downdrafts, as well as offering solid diversification benefits. Further, dividend-paying stocks may provide some protection against rising inflation, in contrast to fixed-rate bonds and longer-duration high-growth equities. In fact, as we saw in the first half of the year, the traditional 60/40 stock-bond portfolio failed to protect capital as the impacts of generational-high inflation and rising interest rates drove declines in both asset classes simultaneously.
While not completely immune to these challenges, dividend stocks are a corner of the equity market that historically, and thus far in 2022, have been less impacted by rising rates as investors have rewarded companies with strong cash flow generation and the ability to maintain or grow dividend payouts (Exhibit 3).
Exhibit 3: Dividend Stocks—A Shelter in The Storm
iShares Core High Dividend ETF (HDV) vs. the S&P 500® Index
Source: Artisan Partners/Bloomberg. As of 11 Aug 2022. Past performance is not a reliable indicator of future results.
Due to their lower duration, dividend stocks are less impacted by rising rates than the broader equity market. In these environments, investors are more likely to favor businesses that can maintain or grow their dividend payouts and those with resilient cash flows and earnings power. Vital to this resilience is pricing power—the ability to pass on increased costs by raising prices. Companies that provide essential products and services, have unique or differentiated assets and/or dominant market positions, are more likely to have pricing power and earn inflation-adjusted dollars.
Regardless of the specific market environment, we believe dividends are an important component of an investor’s total return over any long-term investment horizon. In fact, from 1990 through the first half of 2022, the S&P 500® Index has produced a total annualized return of 9.82%, with 2.25 percentage points or nearly 25% derived from dividends. That may not seem like much, however over those 32.5 years, if you had invested $10,000 in the S&P 500® Index, you’d have nearly twice as much at the end of the period when factoring in dividends compared to the price-only return (Exhibit 4). So, ask yourself, Got Dividends?
Exhibit 4: The Power of Dividends and Compounding
The Growth of $10,000 (Jan 1990 - Jun 2022)
Source: Artisan Partners/Bloomberg. Past performance is not a reliable indicator of future results.
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