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Will the S&P 500's Dividend Yield Ever Go Back to Normal?

Will the S&P 500's Dividend Yield Ever Go Back to Normal?
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Tuesday, 14 August 2018 09:40 AM Current | Bio | Archive

The S&P 500 currently has a dividend yield of 1.8 percent. But it wasn’t always this way. The long-term historical average yield of the S&P 500 is 4.3 percent.

Today’s dividend yield is less than half of the S&P 500’s historical average. And dividends matter for total returns. Approximately 40 percent of the S&P 500’s total returns have come from dividends.

There are two causes for the decline of the S&P 500’s dividend yield:

  1. Lower payout ratios
  2. Higher Stock Market Valuation

Lower Payout Ratios

The constituents of the S&P 500 pay out a lower percentage of their profits now than they did in the decades prior to the 1990s.

In fact, four of the six largest S&P 500 stocks by market cap don’t pay any dividends at all. Those 4 are:

  • Amazon (AMZN)
  • Google (GOOG)
  • Berkshire Hathaway (BRK.A)
  • Facebook (FB)

Since the S&P 500 is market cap weighted, this means these large companies have a disproportionately large effect on the S&P 500’s dividend yield.

The growing prevalence of share repurchases has also reduced dividend payout ratios. Corporations can return cash to shareholders through either share buybacks or dividend payments.

Dividends are taxed, while share repurchases aren’t. Additionally, share repurchases reduce the number of shares outstanding which should (all other things being equal) increase a stock’s price.

With many management teams compensated in part on stock price performance, this makes share repurchases an attractive option to return cash to shareholders relative to dividends for corporate management teams. It should come as no surprise that share repurchases have grown in popularity since the mid 1990s.

Lower payout ratios are not the only cause of lower yields today. Higher valuations play a role as well.

Higher Stock Market Valuation

The S&P 500 is overvalued relative to its historical averages. It has a historical average price-to-earnings ratio of 15.7, which is much lower than its current price-to-earnings ratio of 24.4.

If the S&P 500’s price were to decline so that the index traded in line with its historical average price-to-earnings ratio of 15.7, the S&P 500’s dividend yield would rise from 1.8 percent to 2.8 percent.

But this doesn’t account for why the S&P 500 is overvalued today. Low interest rates play a part. Low interest rates push the value of real assets (including stocks) higher because the "risk-free" alternative of T-Bills pays less.

Interest rates have begun to rise as the United States’ economy has strengthened, but are still very low historically.

Will We See a Return to ‘Normal’ S&P 500 Yields?

It appears that the S&P 500’s lower yield is here to stay. It’s possible the S&P 500 reverts to its historical average valuation multiple. This would push yields higher than they are today — but still nowhere near historical average dividend yields in the 4- to 5-percent range.

Share repurchases are more tax efficient and tend to be better for corporate executives (depending on how they are compensated). Because of that, it’s very unlikely that share repurchases lose ground to dividends over the long run.

The only way that the S&P 500’s dividend yield will every return to averages of 4 to 5 percent over long periods of time is for share repurchases to fall to a trivial amount. This is extremely unlikely except in the event of a serious change to the tax code (taxing share repurchases, not dividends, as an example).

For better or worse, investors will need to become comfortable with the "new normal" of low dividend yields in the S&P 500. It is more likely that the S&P 500’s payout ratio slowly declines further rather than rises from this point.

Ben Reynolds is CEO of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth stock portfolios for the long run.

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The S&P 500 currently has a dividend yield of 1.8 percent. But it wasn’t always this way. The long-term historical average yield of the S&P 500 is 4.3 percent.
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2018-40-14
Tuesday, 14 August 2018 09:40 AM
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