By Jack Hough
Waning economic growth, high unemployment, widespread cynicism and distrust of government — the 1970s were a difficult time to be a stock investor.
Following two decades of go-go-growth and easy share price gains, returns were suddenly difficult to come by. Sound familiar?
With stocks down 16% from April, and investors bracing for more trouble ahead, it’s worth considering how dividends in the 1970s made the difference between a lost decade and a merely stingy one. If it seems to regular readers that I mention dividends roughly as often as the Pope mentions Jesus, here’s why.
From 1930 through September 2010, the S&P 500 index returned 9.3% a year, on average, and dividends contributed 44% of that return, according to a study by Fidelity Investments. There’s good reason to believe that economic growth and thus stock returns going forward won’t match the average of the past eight decades (see “The New Normal–4% Stock Returns?“). After all, those years included periods like the bubbly 1990s and the early 2000s, when stock and house prices bloated and consumer spending soared.
Between 1990 and September 2010, dividends contributed just 27% of returns. But using such an unusual time as a frame of reference is a mistake. If anything, the 1970s, located smack in the middle of two periods of breathless expansion, should serve as a guide to what happens when returns don’t come easy.
Total returns for the S&P 500 index averaged just 5.9% during the 1970s. Dividends contributed 71%.
Those numbers are too flattering to price gains. Inflation consumed all of the gains and then some. Dividends made the difference between staying afloat and sinking. Between 1974 and 1980, when inflation roared at an average of about 9% a year, gains alone produced less than 5% in yearly returns, while gains plus dividends offered about 10%.
The current period isn’t quite like the 1970s, for two reasons. Inflation is muted, and stock investors have already suffered lousy returns for a decade. Both of those are reason for optimism. There are plenty of theories on how to fix an economic downturn, but the only truly known cure is time and plenty of it. Stock prices already look reasonable to fundamental measures of value like earnings and cash flow, so investors who buy today can expect healthy is not huge long-term returns.
But the market is a bit stacked against them. The S&P 500 index carries a dividend yield of just 2.3%, higher than it was during the bubbliest years of the past decade, but low compared with either its longer history or yields in Europe today.
That’s mostly because U.S. firms have gotten stingy. S&P 500 members paid less than one-third of profits as dividends last year, a record low. And more members pay nothing today than in the past. The largest and thus most heavily weighted index member, Apple (AAPL), is one of them. There are signs that dividends are gaining favor again. More companies have raised or initiated payments this year so far than during the same period in any year going back at least to 2004, according the data from Standard & Poor’s.
However, if yields are to make up the bulk of total returns in coming years, investors might not want to wait for S&P 500 members to come around. One option is to select individual stocks with stable profits and sizeable yields. In recent columns I’ve highlighted three groups as being cheap than their fundamentals warrant: old tech, including Microsoft (MSFT) and Intel (INTC); drugs, including Eli Lilly (LLY) and Pfizer (PFE); and defense, including Raytheon (RTN) and Northrop Grumman (NOC). Price-to-earnings ratios are in single digits and dividend yields average over 4%.
Another option is to choose an index fund that bases company weightings on fundamental measures of value instead of stock market values. The WisdomTree LargeCap Dividend Fund (DLN) weights companies according to the dollar amounts they spend on dividends. It yields 3.4%.