A benign economic environment, strong free cash flow generation and healthy balance sheets underpin the case for companies to maintain their cash distribution in the form of dividends. The generally low yield environment bodes well for high dividend yielding stocks as investors continue to hunt for yield.

Dividends are a large portion of total return

Not only have investors focused increasingly on dividends as a form of income, dividend investing has also benefited from the tailwinds of a gradually changing economy. Over the past decades, companies have grown more capital-light while maintaining their free cash flow margins. This provides them with more leeway to increase their dividend payout. Indeed, over the last 40 years, the average payout ratio has risen from around 35% to nearly 50% in mid-2016 – behavior which the market has rewarded.*
 

With a growing dividend payout as well as currently low nominal interest rates, the dividend yield has become a more important part of equities’ total return. Over the 40 years to end 2010, dividend returns accounted for about a third of the non-US developed market total return. Since 2010 that figure has risen closer to half*. In the US, dividends are less popular so companies often return capital to shareholders via buyback programs.

Combine dividend yield with quality criteria for better results
The dividend factor has long been a focus of academic as well as practitioners' research as they seek ways to generate outperformance. Many money managers believe that the dividend yield is a value adding factor. However, picking stocks solely on the basis of their current dividend yield may not be advisable. A stock with a high yield may be a genuinely attractive investment opportunity or it may have experienced a sharp drop in price which would inflate the dividend yield and render the stock a value-trap. We believe that a focus on companies that exhibit both high dividends as well as strong balance sheets, healthy levels of profitability, good cash flow generation and lower risk characteristics should lead to better results in form of more attractive risk-adjusted returns.
 

Urs Raebsamen, Senior Equity Specialist