Dividend stocks perform better over time

It is a common misconception that most of the returns to investors who invest in stocks have come from capital growth. However, since 1926 nearly half of the 10.3% annual stock market return has come from dividends and dividend reinvestment. As an example, over the past 70 years, ending December 31, 2002, dividends contributed almost 40% of the average annual return of stocks on the S&P 500 Composite Index.

There are a number of formal studies that have found dividend stocks provide higher returns. For example, one study of monthly returns by S&P 500 companies over 31 years found that dividend-paying companies significantly outperformed non-dividend-paying firms by 0.37% per month. The sample of companies used in the study was based on returns in 217 months during which the S&P 500 had a positive return and 155 months when it did not.

Although stock prices tend to fluctuate more wildly, dividend returns tend to be more consistent, providing returns more silently but surely over time. As such, it's not a surprise that when the market is bearish, dividend stocks outperform their non-dividend-paying counterparts. The study found that dividend-paying companies provided 0.9% more return than non-dividend-paying companies during down markets.

The interesting thing is, however, that even in up markets, stocks held in dividend companies can still provide better returns than non-dividend-paying stocks. The study found that dividend stocks were returning 0.16% more than non-dividend-paying companies during up markets. Although this obviously depends on the state of the market at the time and the time period examined, it suggests that dividend stocks are in the background performing for their shareholders, while most attention is focused on stocks whose share prices are rising. The simple is that most people are captivated by the possibilities of their stocks doubling or tripling over short periods of time and most people sell and buy much more frequently in times like these.