History shows highest yields don’t equal highest returns

High yielding equities do not equal the highest returns for investors, warned today research by BlackRock’s Global equity income fund.

Investors focusing only on the highest current yields in the markets are doing so at the expense of quality and may experience lower returns over time, as less than half of the stocks yielding more than 10% typically distributed the entire expected dividend over the 1976 – 2012 period.

“Many dividend investors, including dividend-themed funds, focus their search on locating the highest yielding stocks in the market. The global market yield is currently around 3% and the logic is often that a stock which generates a higher dividend yield, say 6%, will deliver greater return when compared to a stock which only delivers 3%,” said Stuart Reeve, co-manager of the fund.

But the relationship could not be that simple.
“History shows us that an equity’s risk-adjusted return begins to fall when the dividend yield reaches a certain point. By analysing long-term data, we found that the second and third deciles of yielding stocks produced the best risk-adjusted returns, whereas moving to the top 10% of yielding stocks resulted in a significant reduction in returns,” he added.

According to the manager, a very high yield often signifies that a company is distressed and may not actually be able to pay its dividend going forward.

“While an attractive yield is an important component of total return, we believe dividend growth is even more powerful over the long term, through the compounding of growth on growth,” he said.

A good example of a stock which produces this powerful combination of dividend yield and dividend growth is British American Tobacco. “Not only is this company yielding roughly 4%, but it has been able to grow that dividend by about 17% annually for the last 5 years,” Reeve said.

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