What is the Dividend Strategy in Stocks Trading?

A dividend strategy is an investment strategy that invests specifically in companies with an above-average dividend and the prospect of rising dividends in the future. Dividend yield and historical dividend increases often serve as a benchmark and selection criterion. In addition to the amount of the dividend, many investors also pay attention to the payout ratio and other fundamental key figures.

Where does the dividend strategy come from?

Investing in high-dividend stocks has become increasingly popular with private investors in recent years. While growth stocks and especially tech companies were still considered promising investments for the future at the end of the 1990s, disillusionment followed with the bursting of the dotcom bubble and a few years later with the financial crisis. Suddenly, conservative (value) investments were back in fashion.

However, the idea of focusing on companies with high dividend yields is not new. The forefather of the dividend strategy (and of value investing) is Benjamin Graham, who in 1949 recommended in his standard The Intelligent Investor that one should invest in the 10 Dow Jones stocks with the lowest price-earnings ratio (P/E) and hold these stocks for 1 to 5 years. A trading approach that later became known and popular in the USA in a slightly modified form as the Dogs Of The Dow strategy.

Key Takeaways

  • The dividend strategy focuses on shares with a high dividend yield.
  • Dividend stocks per se do not outperform the overall market.
  • Other fundamental factors should be taken into account.

Advantages & disadvantages

Is a higher performance possible with the dividend strategy?

Regular income of 5-10 % of the invested capital sounds very attractive at first. However, for the overall performance of a share (price gains + dividends) it makes no difference whether the dividend is paid out to shareholders or not.

Where does the dividend come from?

The dividend is that part of the profit of a company that is distributed to the shareholders. Each company can decide for itself whether a dividend is paid and if so, how much.

Dividend deduction

If a dividend is paid out, money flows out of the company, which is why the value of the company decreases. This is reflected in a share price that falls exactly by the amount of the dividend paid out (dividend discount). For a shareholder, it makes no difference whether he has a share in his portfolio that is worth EUR 100 and does not pay a dividend, or whether the company pays a dividend of EUR 5, but the share price is then only quoted at EUR 95.

Dividend shares vs. total market

One of the most exciting questions is, of course, whether the total return (total performance) of shares with a high dividend yield is better in the long term compared to the overall stock market. To investigate this, we compare the performance of a number of ETFs.

S&P 500 vs S&P 500 Dividend Aristocrats

The S&P 500 Dividend Aristocrats Index includes shares of the S&P 500 that have increased dividends every year for the past 25 years. We compare the total performance of the index with the total performance of the S&P 500 using an ETF with an adjusted price history (which reflects the total performance/total return).

For the S&P 500 we use the SPDR S&P 500 ETF (SPY); for the S&P 500 Dividend Aristocrats we use the Pro Shares S&P 500 Aristocrats ETF (NOBL).

As can be seen in the screenshot, the two indices or ETFs have achieved a similar total return in recent years. In the meantime, one or the other ETF has outperformed the other, but in the medium to long term it can be said that the performance has been roughly the same.

Top 10 dividend ETFs vs S&P 500

Next, we compare the performance of the SPDR S&P 500 ETF (SPY) with a selection of five of the ten most popular dividend ETFs. I have selected those ETFs that have a price history going back to 2007.

These are the following ETFs:

  • Vanguard Dividend Appreciation ETF (VIG)
  • Vanguard High Dividend Yield ETF (VYM)
  • iShares Select Dividend ETF (DVY)
  • SPDR S&P Dividend ETF (SDY)
  • First Trust Value Line Dividend Index Fund (FVD)
  • Under the following link you can go directly to the current performance chart: to the current chart

Dividend as a quality feature

A company can only pay a dividend continuously and increase it year after year if sales and profits are stable or growing. Therefore, dividend shares or dividend aristocrats are often considered quality shares.

However, there is a danger in looking at the dividend yield alone: if a company is in serious trouble and the share price falls sharply as a result, but the dividend remains stable, the dividend yield increases.

In other words, if “blind” investments are made in companies with a high dividend yield, not only value stocks will be included, but also companies that have their best days behind them.

It therefore makes sense to use additional selection criteria when investing in individual stocks, e.g. the payout ratio, sales and profit growth, debt ratio, sustainability of the business model, etc.

Conclusion: For whom is the dividend strategy suitable?

Whether a company distributes a high dividend or keeps the profit in the company is initially irrelevant for the total return on a share. Therefore, a dividend cannot be regarded as additional income. Nevertheless, the dividend strategy is also popular with many private investors and offers some advantages.

On the one hand, it is a conservative and rather defensive investment approach that focuses more on stability than on high growth. Dividend stocks are often value companies with long-term successful and crisis-proof business models. However, dividend yields should not be the sole selection criterion here.

For investors who do not want to reinvest the dividends and see them, for example, as a kind of supplementary pension, the regular and higher cash flow can also be a reason for the dividend strategy.

The dividend strategy can also be used as part of an overall portfolio on a separate account and thus, for example, be a counterweight to a growth investing strategy.

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