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The Power of Dividend Investing

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The Power of Dividend Investing

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The Power of Dividend Investing

If you start talking about dividend investing at your next cocktail event, it’s possible that other patrons may not see you as the life of the party.

But that’s okay – because while dividends are not necessarily sexy, they are a foolproof way to reel in consistent, predictable returns in the market. And for decades, seasoned investors have leaned on dividends to help power their portfolios through both good and bad times in the market.

What is a Dividend?

When a company earns a profit, it essentially has two options.

1. Re-invest in the business
This is the option chosen by many high-growth companies. They pay down debt, or expand their operations to make more profit in the future.

2. Issue a dividend to shareholders
A dividend is a share of after-tax profit of a company, distributed to its shareholders according to the number and class of shares held by them.

How and when is a dividend issued?

  • Both the amount and timing of dividends is determined by the Board of Directors
  • Usually for public companies, dividends happen on a quarterly or annual basis
  • Most dividends are declared by large and established “blue chip” companies (i.e. P&G, McDonald’s)
  • Dividends are often paid if a company is unable to reinvest its cash at a higher rate than shareholders

Most importantly for investors, dividends from good companies should be predictable and sustainable. Some companies like Coca-Cola have been paying out uninterrupted dividends on common stock for over a century.

The History of Dividends

1250
The first company to ever pay a dividend was likely a French bank called Société des Moulins du Bazacle, which was formed in 1250.

1602
The Dutch East India Company was the first company to offer shares of stock. It famously paid a dividend that averaged around 18% of capital over the course of the company’s 200-year existence.

1684
The Hudson Bay Company was likely the first North American company to have paid a dividend. The first dividend went to shareholders 14 years after the company’s formation in 1670, and was worth 50% of the par value of the stock.

1910
In the early 20th century, most investors only cared about dividends. At the time, stocks were expected to have a higher dividend yield than bonds to compensate investors for the extra risk carried by equities.

2003
Microsoft declares its first dividend after 28 years of rapid growth.

Today, roughly 422 of the 500 stocks on the S&P 500 pay a dividend, including companies like 3M, Chevron, Walmart, and McDonald’s.

Why is Dividend Investing Powerful?

Most investors are aware of the power of compound interest – and dividends work in a similar way, especially when dividends get reinvested back into the company.

That’s why investing $10,000 in Coca-Cola in 1962 would have yielded more than $2 million by 2012, which is 50 years later. Dividends get reinvested to buy more stock, which produces more dividends, and so on.

The advantages of dividend investing are as follows:

  • Companies can increase dividends over time. (P&G, for example, has increased their dividend every year for 60 years)
  • Companies can’t fake dividends – a company either declares a dividend, or it doesn’t
  • Dividends protect against inflation. (Dividends have increased 4.2% since 1912, and inflation has increased 3.3%)
  • Dividends create intrinsic value, as they generate cash flow for investors
  • Dividends can help combat volatility – that’s because dividend yield increases as the market price of a stock falls, making the stock more attractive

Dividends are a key way for companies to give back to shareholders, and in the right situation, dividend stocks can be a powerful component in an investor’s portfolio.

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Markets

How Disinflation Could Affect Company Financing

History signals that after a period of slowing inflation—also known as disinflation—debt and equity issuance expands.

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Chart showing U.S. Equity Issuance Deal Value from 1980-2000. Equity Issuance goes up over time, with the 300% increase in 1983 highlighted at the end of the disinflation period.
The following content is sponsored by Citizens Commercial Banking

How Disinflation Could Affect Company Financing

The macroeconomic environment is shifting. Since the second half of 2022, the pace of U.S. inflation has been dropping.

We explore how this disinflation may affect company financing in Part 2 of our Understanding Market Trends series from Citizens.

Disinflation vs. Deflation

The last time inflation climbed above 9% and then dropped was in the early 1980’s.

Time PeriodMarch 1980-July 1983June 2022-April 2023*
Inflation at Start of Cycle14.8%9.1%
Inflation at End of Cycle2.5%4.9%

* The June 2022-April 2023 cycle is ongoing. Source: Federal Reserve. Inflation is based on the Consumer Price Index.

A decrease in the rate of inflation is known as disinflation. It differs from deflation, which is a negative inflation rate like the U.S. experienced at the end of the Global Financial Crisis in 2009.

How might slowing inflation affect the amount of debt and equity available to companies?

Looking to History

There are many factors that influence capital markets, such as technological advances, monetary policy, and regulatory changes.

With this caveat in mind, history signals that both debt and equity issuance expand after a period of disinflation.

Equity Issuance

Companies issued low levels of stock during the ‘80s disinflation period, but issuance later rose nearly 300% in 1983.

YearDeal Value
1980$2.6B
1981$5.0B
1982$3.6B
1983$13.5B
1984$2.5B
1985$12.0B
1986$24.2B
1987$24.9B
1988$16.9B
1989$12.9B
1990$13.4B
1991$45.2B
1992$50.3B
1993$95.3B
1994$63.7B
1995$79.7B
1996$108.7B
1997$106.5B
1998$97.0B
1999$142.8B
2000$156.5B

Source: Bloomberg. U.S. public equity issuance dollar volume that includes both initial and follow-on offerings and excludes convertibles.

Issuance grew quickly in the years that followed. Other factors also influenced issuance, such as the macroeconomic expansion, productivity growth, and the dotcom boom of the ‘90s.

Debt Issuance

Similarly, companies issued low debt during the ‘80s disinflation, but levels began to increase substantially in later years.

YearDeal Value Interest Rate
1980$4.5B11.4%
1981$6.7B13.9%
1982$14.5B13.0%
1983$8.1B11.1%
1984$25.7B12.5%
1985$46.4B10.6%
1986$47.1B7.7%
1987$26.4B8.4%
1988$24.7B8.9%
1989$29.9B8.5%
1990$40.2B8.6%
1991$41.6B7.9%
1992$50.0B7.0%
1993$487.8B5.9%
1994$526.4B7.1%
1995$632.7B6.6%
1996$906.0B6.4%
1997$1.3T6.4%
1998$1.8T5.3%
1999$1.8T5.7%
2000$2.8T6.0%

Source: Dealogic, Federal Reserve. Data reflects U.S. debt issuance dollar volume across several deal types including: Asset Backed Securities, U.S. Agency, Non-U.S. Agency, High Yield, Investment Grade, Government Backed, Mortgage Backed, Medium Term Notes, Covered Bonds, Preferreds, and Supranational. Interest Rate is the 10 Year Treasury Yield.

As interest rates dropped and debt capital markets matured, issuing debt became cheaper and corporations seized this opportunity.

It’s worth noting that debt issuance was also impacted by other factors, like the maturity of the high-yield debt market and growth in non-bank lenders such as hedge funds and pension funds.

Then vs. Now

Could the U.S. see levels of capital financing similar to what happened during the ‘80s disinflation? There are many economic differences between then and now.

Consider how various indicators differed 10 months into each disinflationary period.

January 1981April 2023*
Inflation Rate
Annual
11.8%4.9%
Inflation Expectations
Next 12 Months
9.5%4.5%
Interest Rate
10-Yr Treasury Yield
12.6%3.7%
Unemployment Rate
Seasonally Adjusted
7.5%3.4%
Nominal Wage Growth
Annual, Seasonally Adjusted
9.3%5.0%
After-Tax Corporate Profits
As Share of Gross Value Added
9.1%13.8%

* Data for inflation expectations and interest rate is as of May 2023, data for corporate profits is as of Q4 1980 and Q1 2023. Inflation is a year-over-year inflation rate based on the Consumer Price Index. Source: Federal Reserve.

The U.S. economy is in a better position when it comes to factors like inflation, unemployment, and corporate profits. On the other hand, fears of an upcoming recession and turmoil in the banking sector have led to volatility.

What to Consider During Disinflation

Amid uncertainty in financial markets, lenders and investors may be more cautious. Companies will need to be strategic about how they approach capital financing.

  • High-quality, profitable companies could be well positioned for IPOs as investors are placing more focus on cash flow.
  • High-growth companies could face fewer options as lenders become more selective and could consider alternative forms of equity and private debt.
  • Companies with lower credit ratings could find debt more expensive as lenders charge higher rates to account for market volatility.

In uncertain times, it’s critical for businesses to work with the right advisor to find—and take advantage of—financing opportunities.

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