MANY COMPANIES don’t pay dividends, so looking at dividend yields won’t necessarily tell you whether one stock is better value than another. But it can be useful in gauging how expensive the overall market is. As of year-end 2020, the S&P 500 companies were yielding 1.6%. That’s an improvement over the 1.2% at year-end 1999, but below the level of earlier decades. Yields stood at 3.5% at year-end 1969, 5.2% at year-end 1979, 3.2% at year-end 1989 and 2% at year-end 2009, and have averaged 2.8% over the past 50 years and 3.9% over the past 100 years.
The market’s dividend yield has trended down partly because stocks have become more expensive over time and partly because companies have instead used their spare cash to buy back their own shares. Historically, total shares outstanding have grown almost every year, as employees exercise stock options and companies issue new shares to raise cash or finance acquisitions. But that’s changed in recent decades: Corporations have been big buyers of their own stock, and these share buybacks have roughly offset new issuance.
Buybacks are seen as a more tax-efficient way of returning money to shareholders, because the money is used to cash out investors who want to depart without saddling remaining shareholders with taxable dividends. Buybacks may also reflect the current century’s slow-growth economy. With fewer chances for profitable expansion, some companies have decided instead to use spare cash to repurchase shares.
Trouble is, companies appear to be terrible market timers. They aggressively bought back their own shares ahead of the 2007 stock market peak, but slashed their buying during the market slump that followed. Similarly, they repurchased shares aggressively during the 2009-20 bull market, but many companies appear to have quit buying their own stock amid 2020’s market downturn. Partly that’s because companies have been looking to conserve cash. But also it seems buybacks are driven less by companies’ belief that their shares are undervalued and more by a desire to offset the dilution caused by employees exercising stock options. The latter is more likely to happen during buoyant markets, as the options gain value along with rising share prices.
Will buybacks return as the stock market and the economy recover from 2020’s slump? Probably. Still, buyback programs are often quietly abandoned, while dividends seem like a surer thing, because companies are loath to cut their dividend. Knowing they have to pay a regular dividend can also be a healthy discipline for management, forcing them to be more careful in handling the company’s cash.
Meanwhile, for investors, dividend-paying stocks can provide a fairly reliable and growing stream of income—one that’s arguably superior to that generated by bonds and cash investments. Most bonds generate a fixed stream of interest, leaving investors vulnerable to inflation, while the income from cash investments can fluctuate wildly from year to year, along with changing short-term interest rates.
By contrast, over the 50 years through year-end 2020, the dividends paid by the S&P 500 companies grew at an average 6% a year, comfortably ahead of the 3.8% annual inflation rate. Will dividends continue to be a source of growing income in this era of stock buybacks? It seems so. Here’s one indication: Over the 15 years through 2020, dividends paid by the S&P 500 companies grew at a robust 6.6% a year, versus 1.9% for inflation.
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